A new report by Professor Chris Brady and Dr Richard Ramyar of Cass Business School predicts that the number of people in the UK with a spread betting account could more than double from its current level of 400,000 to one million by 2011. To achieve this, the industry has to extend its appeal to a more mass market audience by going beyond their existing client base of white affluent males under 45 years old to embrace women, ethnic minorities, older people and international markets.
To sustain the industry's current rate of expansion of between 20 - 26% per annum, the report claims that it must focus more on educating consumers on the role spread betting has, as a serious investment tool that can become part of a balanced portfolio. However, it argues that the industry suffers from the stigma associated with betting when in actual fact there is little difference between it and trading. In addition, unless it overcomes this perception issue, its numerous attractions such as providing consumers with tax-free profits and the ability to hedge against falling markets, or even benefit from them, will remain largely overlooked.
Chris Brady, Professor of Management at Cass said: "The spread betting industry has considerable potential to grow but to achieve this over the longer term it needs to move towards the mass market. What seems exotic and beyond the grasp of all investors is really just a form of trading. Indeed, derivative trading goes as far back as 3,800 years ago to help Babylonian farmers sell grain."
"The industry's greatest problem comes from no longer being adolescent. There is relatively little scope remaining to differentiate products but there must be focus on greater simplicity. Spread betting firms need to move beyond the young, white male professional into female, grey, ethnic and international markets."
Dr Richard Ramyar added: "The industry faces a considerable educational task to convince the public, the regulators and legislators that all forms of trading are essentially the same type of activity. The only difference is the level of risk - which can range from post office savings at one end to betting on the proverbial two flies at the other end. For the industry to expand, it must work harder at segmenting and targeting the public because being first to market is no longer sufficient."
The UK spend on betting has increased sevenfold since the chancellor's cut on betting tax in 2001, with £59 billion being spent last year alone. According to research giant Forrester, 76% of the UK's 29 million adult internet users admit to regularly placing a bet either online or offline. This change in the UK's wider betting habits cannot fail to have an impact on the spread betting industry as people look for new experiences beyond the traditional. In the UK the spread betting industry has been at the forefront of offering online trading and analysis tools, frequently stealing a march on traditional share trading services. The current market for spread betting is almost completely internet based and is in a similar market to other online trading accounts. The investors currently exploiting online trading services are predominantly white, male, affluent internet users who are under 45 years old. Of course, this is not unexpected. The early adopters of all new technology applications are generally this same group, whether they are trading online, the first to buy books or home electronics online.
The needs of this group will change as it gets older. Pensioners currently only number 5% of the customer base, a figure that will grow. They are already being encouraged to worry about their insufficient pension pots and they will begin to structure more of their portfolios with a view to the long-term and managing risks to their capital. Finspreads, for example, has seen an average 15% year on year growth in the 55+ market since 2002. Successfully meeting the challenge of retaining existing customers will further change the age profile of the customer base. And this is without mentioning that the population at large is aging.
Current adverts for CFDs and spreads tend to revolve around macho objects of desire: glitz, cars, aeroplanes and the like. This will necessarily change for any longer term products that are offered to an older age market. Any products with longer expiries, perhaps measured in years, would compete at least indirectly with traditional brokers who do not aspire to the wheeling-dealing image.
The spread betting and CFD companies will therefore have to cater for these older customers in the future. However, this market segment known as 'empty nesters, silver surfers' are only one element of the potential market so far under-represented in the financial gambling arena. If, as expected, there will be an annual growth rate of between 20% and 26% in the number of spread bets and CFDs used by retail investors, that growth is unlikely to occur simply in existing segments of the market.
If these products are to be more widely used, logic dictates that the profiles of the investors must change. The challenge for the industry is to decide which other groups are going to be interested in spread betting or CFDs in future years. Also, will the industry be able to serve these groups without cannibalising their existing client base?
Traditionally women have been conspicuous by their absence in spread betting and CFDs. In recent years, however, this has been changing. Sandy Jadeja, Chief Market Analyst of Finspreads, has seen an increase in their numbers trading and attending his educational seminars, at first steadily, and then growing more rapidly; and this trend seems unlikely to reverse. Interestingly, Mr. Jadeja also notes that women have a different, more calculated, trading mentality. They tend to prepare their research more effectively and be more cautious. Sheila Gleason, Marketing Operations Director at Barclays Wealth Management, has noticed that Barclays' own research shows that 'women do about 40% more research than men on every trade'. Research from Digital Look shows the same result - women clearly outperform men when investing.
They also trade or game online less compulsively than men and are less likely to become addicted. Finspreads has seen a 10% year on year growth in female clients over the past 2 years, a figure fairly representative of the industry at large. Compared to when the company formed in 1999 they now have over 300 times the number of female customers. However, despite the growth in female spread-betters they are only in the region of about 10% of all account holders. This correlates with the percentage of women in the overall gambling population which is usually stated to be between 8%-12%. There is concern in the industry, therefore, that the rapid recent growth in female participation may have plateau-ed at the general level.
Contrary evidence is provided by online poker where there has been a dramatic increase in the numbers of women to somewhere in the region of 45% of punters. It is not entirely clear what has driven this increase - anonymity, challenge, complexity and hygiene have all been suggested as reasons. The spread betting industry will need to understand what drove this enormous rise in female participation and attempt to replicate it for spread betting. As mentioned before, while adverts for CFDs and spreads focus on the macho online gaming billboards have even included fluffy bunnies to appeal to the female consumer. Whatever it takes the spread betting industry must address it.
Ethnic minorities are also likely to be important sectors where growth might be expected in the retail derivatives industry. Although immigration is not new, growth in the United Kingdom population has been increasingly driven by immigration since the mid-1990s. Will the first wave of immigration from the new EU states settle and prosper here like past hard-working immigrants? Past immigration from the Indian subcontinent has developed into an affluent middle class. According to the Institute of Asian Professionals 10% of business startups are the brainchilds of Asian entrepreneurs, even though they make up only 5% of the UK population. Just as the Hispanic constituency in the United States is growing in importance for marketing a wide range of products, so too could British ethnic groups. Australia provides an interesting experiment in targeting ethnic groups. Australians with a far-eastern heritage are viewed as a specific market segment and Britain is certainly following suit.
Adrian Buthee of Two Way Trade, a CFD brokerage, points out that the British Asians already constitute a very noticeable group of traders, and certainly the largest ethnic minority group. It may be politically incorrect to characterise racial stereotypes but it would also be commercially incompetent to ignore 'a priori' evidence that suggests preferences for financial products based on ethnic background. It is important, therefore, to segment individual markets not only by age and gender but also by ethnic sub-groups if the evidence for so doing is strong.
The industry will also continue to seek out new international markets. Ireland and Australia are already important markets, but these are not incredibly different environments from the British market. In the far-east and the Indian subcontinent, however, there is a greater tendency to think of commodities such as gold as an investment. The Chinese are even planning to open a theme park entirely dedicated to the yellow metal. The £14 million (€20 million) park will allow visitors to watch gold being mined and processed. The more adventurous will even be able to mine gold for a day. For the more serious Chinese 'gold-bug', a special edition of the China Economic Daily was published in two gold versions. The more expensive issue cost each reader just over £4,500 (€6,600) to catch up on the news and used 500 grams of gold.
Per-capita income of China's urban residents grew by 9.5 percent in the first half of last year. According to a report of the Gold Field Mineral Service, a metals consultancy, this income growth will lead to annual gold sales in China of 600 tons in five years.
If proven to be correct, China would replace India as the largest gold consumer in the world. The Chinese certainly have an appetite for the commodity markets as evidenced by the impressive over-attendance and crowding when companies such as IFX Markets run seminars and education events in Shanghai. There is also an undeniably deep gaming culture amongst the Chinese that extends from financial markets to the more obscure. One bizarre sub-group of people are actually paid to intensively play in simulated online worlds. It may be odd but the imperative is real cash. The in-game currencies have a market value and can be traded on auction sites such as Ebay, at values that the Economist has noted gives some virtual worlds greater GDPs than many small countries. Virtual trading in virtual worlds is, perhaps, the ultimate derivative. As mentioned above we are already close to derivatives cubed, trading in the virtual world may be derivatives to the power of infinity. This gaming and trading propensity is clear to Western companies but relatively untapped.
China's currency, the Renmimbi, has not yet been floated and their favourable export position probably means they may not do so any time soon. However, India may soon float the Rupee and remove currency controls. This freedom will also bring more business into the retail derivatives industry, even to London based firms. In post-colonial times London has retained a certain allure for the Indians in particular. This obvious interest in London is similar to the manner in which many former colonies look to former colonial powers - the financial industry is fortunate both to have a prime financial centre in London and strong historical links to one of the largest emerging markets in the world. Floating the Rupee would also lead to spreads and CFDs on the Rupee that British Asians and Indians nationals would likely trade. It would be relevant as an emerging market trade and would certainly serve as a measure of the volatility in geopolitical relations in the region. Even if there is a delay in floating the Rupee, the leverage that retail derivatives offer allow Indian nationals to get round that limitation.
While spread betters are primarily retail clients, users of CFDs also include financial institutions that need to replicate all the financial benefits of owning an asset. Hedging with CFD issuers already accounts for around 40% of trading of British equities, although the vast majority of this trade is institutional. Nevertheless, spread betting and CFDs have stayed close to the humble roots of the agricultural futures contract. So far they have avoided the complexities of the exotic derivatives offered by banks to large companies. Perhaps over time it is inevitable that more products will be offered to the individual investor and their brokers as financial awareness and education increases amongst consumers. These will probably share some of the more basic features that banks have included in exotics.
To a certain extent it is already happening with products such as `binary bets'. Normal spread betting is similar to trading the markets - you are rewarded or penalised as the market moves similar to as if you own the asset. Binary bets are based on whether or not something will happen - whether the FTSE closes above 5800 at the end of June, for example. In the final days of June the quote for this binary bet will be near to 100 if the FTSE is a long way above 5800, because there is almost a 100% chance it will close above 5800. On the other hand, if you believed that despite this, the market was going to fall substantially and close below 5800, you would go short and wait to cover the bet at the end of June at 0. This is similar to the barrier options that banks sell to corporations. Digital options are another wholesale banking product similar to binary bets, except that the investor profits even if the FTSE breaks 5800 only once before the expiry of the contract. Binary bets are priced using similar models to those employed in wholesale banking.
A range of contracts on property indices could potentially tap into the property fever. Contracts for trading regional property indices like a normal spread bet or swap contracts are all possible. David Mercer of Finspreads notes that Deutsche Bank and Eurohypo completed the first UK property swap on commercial property in January 2005. The deal was between a UK insurance company and a UK property fund where the insurance company wanted to decrease it's exposure by £40 million. The 3 year CFD struck between the parties allowed the two entities to swap their UK property exposure. Basically the seller exchanged the total return on their property portfolio, which encompassed income and capital growth for a LIBOR related return paid by the buyer based on a notional principle of £40 million.
Mercer said "It is only a matter of time before these swaps are conducted on a basket of retail properties and the retail investor can hedge or trade the value of what is generally their biggest asset - their home. The market is potentially huge with 15 million home owners in the UK and an estimated value of £2.8 trillion (£2,800 billion). Our challenge is to simplify the product which allow retail investors to transfer their property risk without the need to buy or sell their home. Speculators or even people who do not own property would buy the CFD and gain exposure to UK property without the need for capital outlay or the risks involved with buying a home. Likewise, homeowners can hedge, on a short term basis, against a decrease in the value of their core asset by selling the CFD".
At the moment there is not enough liquidity in the market and the recognised industry benchmark, the Investment Property Databank UK Property Index, is focussed purely on investment property at this stage. Finspreads are currently in discussion with the providers of property derivatives in the commercial market and aim to be the first to bring the retail product to the street.
Regional disparities in the annual growth of the property market is another consideration for those wishing to extend the property derivative market and distribution.
There will certainly be a market for complex products that serve the needs of more advanced investors. However, the industry must generally err on the side of simplicity. It is simplicity wherein the mass market lies. Extending access and education for the original and more basic products is important to the mass market while ever more exotic products are needed to retain the interest of the specialist financial gambler. There will also be those people who want to trade basic contracts but with more instant feedback of profit or loss. The closest expiries available tend to be daily although hourly and five minute binary expiries are offered by some firms. There is of course nothing stopping a trader from closing a daily position after holding it for only one second. Nevertheless, very short term expiries would certainly target a different and decidedly more speculative market of spread-better. As with extending expiries for the older age market, offering shorter expiries would also allow the industry to target another market with the minimum of changes to their products range.
Yet another market can be found with the likes of Victor Chandler, a traditional bookmaker, which has bricks and mortar outlets in places such as Mayfair. This serves the desire of some of their wealthier customers to take a flutter when it takes their fancy just by popping in. There is no reason why this type of outlet and product could not serve the financial spread betting industry. This market would also be quite different to the online, white male stereotype of existing customers and avoid cannibalising that market.
Another avenue might be the online betting exchange. David Buik of Cantor Index believes that it is only a matter of time before the exchanges turn their full gaze on the financial markets. These website services allow you to offer your own spreads or accept other peoples'. They are quite similar to direct access platforms in other financial markets that allow you to bypass a broker and deal with the market more directly, such as Island or HotSpotFX. Nevertheless, financial betting exchanges have not had the same success as traditional spread betting or CFDs. Most people tend to prefer to deal with the firm itself as there is more confidence that the firm will always provide the liquidity to close out the position when it is needed. This notion, that anonymous `layers' cannot offer liquidity may, however, be purely perceptual and evolve over time.
Additionally, there will be more innovative ways of using the products that already exist. One approach that could appeal to entrepreneurs would be for a non-financial institution to hire a betting team to provide their insurance policies. Look at the position Tottenham Hotspur found itself in.
They were in a position to finish fourth in the Premier League but if they did so they would miss out on participation in the Champions' League (and at least £10m additional revenue) if at the same time Arsenal were to win the 2006 Champions League. The easiest way for them to have insured against such an eventuality would have been to hedge against the losses by betting on Arsenal either to finish fourth and/or to win the Champions League. Betting against certain activities simply acts as an insurance policy but would of course need to be policed by the football league to ensure one party was not incentivised to adversely perform.
New products will be developed and these will be quickly replicated by all firms. Profitability will, therefore, come from managing brand loyalty and from the management of 'interbanking' issues such as liquidity, credit lines and risk management. These choices are very important indeed for the retail derivatives industry. The industry's greatest problem comes from no longer being adolescent. There is relatively little scope remaining to differentiate products. The industry recognises that it needs to move beyond the young, white, male professional into female, grey, ethnic and international markets. According to Ed Warner of Finspreads, it appears that the appeal remains fairly exclusive - customers still tend to be semi-professional or at least aspiring to act as such. Beyond the professional or aspiring semi-professional trader lies the mass market - these are people who do not know what a spread-bet is or could not tell the difference between a CFD and a DVD. They are, nevertheless, quite happy to open online share accounts or hand over money to others to manage for them in collective funds.
As David Jones of CMC Markets points out, "education and educative marketing is the key in bridging the gap in perceptions". Active customers' perceptions of the industry are very different from the perceptions of potential customers. This is quite simply because most potential customers are more solidly "retail" and unfamiliar with the financial industry, let alone spreads and CFDs. Yet spread betting and CFD firms have been the vanguards of online trading services and competitive pricing in Britain. It is spread betting that has given the amateur traders access into what has hitherto been a professional game. This has been fundamental change in consumer choice in a country where traditional share dealing commissions can be three or four times the cost of similar trades in the United States, even before considering stamp duty.
Despite opening up choice, the retail derivatives industry has not explicitly claimed to represent the interests of the mass market. If choice is in the interest of the consumer then perhaps stating this explicitly is important to the industry as regulators move into the area of retail derivatives.
The EU Markets in Financial Instruments Directive (MiFID) extends regulation of the European financial services to contracts for difference, commodity derivatives and credit derivatives for the first time.
Whilst the FSA has regulated financial spread betting in the UK for some time, it is only MiFID that has required Irish financial regulators to assume responsibility from their gaming authorities. In this instance increased regulation to protect the public was in fact welcomed by most of the Irish spread betting industry. They were already accustomed to their UK operations being regulated by the British FSA. This does not mean that all changes in regulation will be welcome, just as other elements of MiFID have been heavily criticised.
Tomas Carruthers, Managing Director of the online financial portal Interactive Investor, points out that; "if the retail derivatives industry does not come together to represent itself it may have strategic choices made for it by future regulators". The Association of Private Client Investment Managers and Stockbrokers, the British Bankers Association and the Association of British Insurers represent other sectors in the financial industry when necessary. Even the most benign industries such as grocers have industry associations that serve as authoritative voices on collective issues. They are also accepted as more legitimate champions of their customers' interests than the statements or lobbying of a single institution. Yet the retail derivatives industry remains comparatively unprotected if there are to be any future regulatory threats.
Notwithstanding, the recent FSA consultation paper which seeks to apply principles-based regulation to listing rules failed to address CFDs in any meaningful way. While acknowledging the need for a comprehensive and transparent disclosure regime, the FSA seemed to say that it was just too difficult. There is another regulatory problem that has failed to receive any genuine discussion; as telecoms technology accelerates towards ultimate convergence who will regulate gambling over the airwaves which is precisely what spread betting is. Will it be the gaming commission, the FSA or perhaps it should be Ofcom?
Given that over 90% of spread betting occurs over the internet and the difficulties of regulating other types of online gambling (sports, poker etc.) has been well documented, it may be that the bigger companies would actually welcome regulation as it provides comfort for the consumer and respectability for the companies. Taking the on-line gambling community as an example, anything (even taxation) that adds respectability to an industry adds value.
Sportingbet.com, one of the online gambling industry leaders, even went to the extent of spending large sums lobbying the US political establishment to tax online betting; surely a unique position for a bookmaker to take.
However, the logic was obvious - taxation adds legitimacy, legitimacy provides comfort. Further, it is not impossible that unforeseen events may lead EU or British regulators to restrict access to products to only high net worth or sophisticated investors. Hedge fund access remains relatively restricted. If that were the case successful retail derivatives firms will be left only competing on operational efficiency and their institutional relationships - brand loyalty is not relevant to professional traders. Professional traders are already likely to hold a number of spread betting and other accounts. This brand-less model of competing only on operational efficiency depends on economies of scale that would certainly lead to consolidation in the industry.
It is likely that at some point in the not too distant future the retail derivatives industry will feel the need to come together in a formal association to create a consensus: a consensus that these products should be available to retail investors, rather than reducing choice. Unlike the United States, Britain does not have a history of competitive commissions or access to leveraged margin accounts. Hopes of a retail derivatives industry have been dashed before. When LIFFE first opened in the 1980s the British retail brokerages rushed to buy seats on the fledging exchange. Retail access to these derivatives never took off in the same way that spread betting and retail CFDs have done. That success and the choice given should be coveted and provides a confident platform of well deserved legitimacy. Serving the mass market does not preclude serving the smaller niche market of professional traders, but it is our opinion that it is easier to lose the opportunity of accessing the mass market.
When the industry first launched binary bets they were wrong to think that the mass market would find them simple. For a traditional gambler binary bets are closer to normal fixed odds bets and thus more familiar. Yet even as education has increased, the average investor in CFDs or financial spread betting does not appear to have found binary bets as easy to understand as a plain CFD or spread bet.
It is likely that increased competition to fulfill investor needs will lead to more innovations. It is, however, just as likely that those more complex products will only be taken up by more experienced traders. "Normal" spread betters and CFD users plainly think in terms of traditional capital gains from price increases.
The retail derivatives mass market is not hugely different from other financial markets such as stock broking. To access this mass market, or at the very least attempt to compete, companies will feel the need to focus on brand and the value added services that they offer their clients. As mentioned earlier, education is a constant theme. The industry has been at the forefront of proactively educating the public through educative marketing and seminars. This will certainly continue. Adrian Buthee, of Two Way Trade CFD brokerage, sees that education process extending not only to seminars and analytical tools, but to full service trader support.
He sees "a growing minority of traders who want to trade independently, but with the opportunity of talking through trades and risks with a broker on the phone". With almost all spread and CFD traders using online systems this is a bold statement, but if it comes to fruition it would represent an important market segment. The traditional stock-broking industry does in fact already offer CFDs to its clients, and often even from within their managed account services.
Angus McCrone, a seasoned commentator and a senior economist for the Centre for Economics and Business Research, points out that "general investment sentiment will drive a lot of the business" regardless of other the developments. It is a sign of the industry's success and growing maturity that it faces the same problem as traditional brokerages. The problem for the industry is to explain to consumers who tend to hang on to their money when the markets are falling that by using retail derivatives they can actually hedge against falling markets, or even benefit from them.
That is the difficulty for the industry as a whole in a nutshell. There is a huge educational task for the industry to convince the public, the regulators and the legislators that all forms of trading are essentially the same type of activity. The only real difference being the level of risk which can be located on a continuum from post-office savings at one end to betting on the proverbial two flies at the other end. It must also be recognised that it is not the product which lies on this continuum but the use to which that product is put and the risk mindset of the user.
Additionally, for the industry to grow, this newly educated public must be segmented and targeted more efficiently because simply being first to market is no longer sufficient. The risk mindset of the consumer is the key factor in trading predispositions so products must have the flexibility to be able to be used in a variety of ways by a variety of investors.
Finally, it is essential that the industry is coordinated and presented as a homogenous and self-regulated group in which investors can place their complete trust. Of course, such a change in perception is far from easy and has much more to do with emotion than rationality. There remains a stigma attached to the terms betting and gambling.
As the 19th century satirist quoted at the opening of the article illustrated, such double standards are nothing new but must be addressed. Unless it is addressed, an industry that adds genuine choice and would enable a larger section of the public to engage in financial trading, will be impeded.
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