Business Opinion/Dominic Coyle:The investment climate has certainly changed when you hear senior executives in financial services pronounce the demise of a highly profitable product.
That was precisely what happened last week when Bank of Ireland Private Banking managing director Mark Cunningham stated bluntly that the "game is over" for private investors using high-risk contracts for difference (CFDs). Cunningham said investors had lost significant sums on CFDs amid the recent market volatility.
CFDs are derivative products where investors can take a position on the future direction of a stock without having to actually buy the underlying shares. They simply place a margin with their broker. This is leveraged by a factor of between five and 10, a move that can rapidly net spectacular gains, but equally will exaggerate losses should they arise.
And they have. Falling markets in recent months have caught CFD investors unawares and many have seen their positions forcibly closed, leaving them nursing heavy losses. Cantor Fitzgerald, one of the largest players in the Irish CFD market, liquidated about €400 million in Irish CFDs in August alone, and there have been further calls on investors to bolster their investment since then.
It has been a rapid change of fortunes. Cunningham noted that CFDs, which were only introduced in the Republic in 2002, had accounted for "north of 50 per cent" of the trading activity on the Dublin exchange in the recent past: activity levels are now thought to have fallen closer to 15 per cent.
Kevin Quinn, a director at Bank of Ireland Private Banking, said its policy "was, and still is, that the risk on these products outweighed the potential return and we never recommended investment in such propositions".
That may be so, but CFDs have certainly been big business for stockbrokers and the Irish Stock Exchange. It is somewhat ironic that one of the most aggressive sellers of CFDs in the Irish market has been Davy, the broker in which Bank of Ireland only last year sold its 90.4 per cent stake.
Two things have conspired to create the rapidly deflating CFD bubble. The longest bull market in recent stock market history has blunted the antennae of investors; risks that many would not even have countenanced a decade ago are now assumed without due consideration - helped in part by the fact that such transactions are free of stamp duty.
On the other side of the equation, CFDs have represented profitable business for stockbrokers. If the money of the well-heeled clients of Bank of Ireland Private Banking and other like-minded wealth managers has not been directed into such highly leveraged products, the question is whose has been? At the start of the summer, more than €1 billion of Irish investors' funds were resting in CFD contracts.
The suspicion is that many of those investing in CFDs should never have been dabbling in such exotic instruments. Either they themselves did not pay sufficient warning to the stark warnings in the small print or they were not sufficiently vetted.
As far back as May 2006, Cantor Fitzgerald tightened its lending criteria in the Irish market. At the time it was stated that the CFD business in Ireland had grown far beyond the expectations of the US company. Cantor decided that investors who failed to provide proof of their ability to sustain losses - via an audited statement of their assets - would be charged a fee 1.25 percentage points higher than other investors if they wished to invest in CFDs.
At the time, market sources in Dublin suggested Irish punters would have an "almost philosophical objection" to providing such information. That being so, how well did the brokers know those clients whose money was directed into CFDs and their ability to withstand adversity?
To what extent did the prolonged bull market play a part in lower resistance - given that most CFDs bet on share prices advancing? Or have investors and their advisers simply fallen victim to a perfect storm in the markets?
To put that volatility in context, one broker pointed out that shares in Ireland's largest bank, AIB, are now trading at a ridiculously low one times book value if you strip out its Polish and US interests. That is a sharp decline by any standards. At the start of the year, AIB was trading at €23.50.
The €17 closing price for the shares last Friday represents a fall of almost 28 per cent - though it is an improvement on the 32 per cent slide the stock was nursing earlier last week.
AIB is not alone. The value of the Irish market as a whole is over 16 per cent less than it was at the end of 2006.
Having taken a back seat as CFDs emerged from nowhere to become the dominant trading element on the stock market, the Irish Financial Services Regulatory Authority is now quizzing stockbrokers about the exposure to CFDs of themselves and their clients.
If Mr Cunningham is right, this particular door may be closing after the horse has bolted. However, chastened investors and increased oversight may reduce the appetite for such exotic products in the foreseeable future, leaving brokers working harder for their money.
