Ali Curi: [00:00:00] Markets ConversatION is an ION podcast where we discuss topics of importance to capital market participants with product owners, subject matter experts, and industry leaders. 

Will Mitting: And we also found small numbers of firms were planning to offer derivatives clearing as well. While I think this is only really an option for the largest retail firms, I think that the number of firms considering clearing will grow once they evaluate the economics of offering listed derivatives to both retail and institutional clients.

Ali Curi: Hi everyone, and welcome to Markets ConversatION, I'm Ali Curi.

On today's episode, Bruce Roberts from ION Markets and Will Mitting from Acuiti will dive into the changing landscape of retail trading in Europe. We'll explore how regulators are suppressing complex instruments like Contract for Differences or, CFDs, forcing brokers to adapt.

However, this shift could open door for listed derivatives markets, traditionally dominated by [00:01:00] institutional investors. Bruce and Will discuss challenges and opportunities for retail brokers as they navigate this new environment. We'll also examine how established institutional players might be impacted by this influx of new retail activity.

Let's get started. Bruce Roberts, welcome back to the podcast. 

Bruce Roberts: Hi, Ali. Great to be back again with you and Will. 

Ali Curi: And a friend of the podcast, Will Mitting. Always good to see you. 

Will Mitting: Great to be here. Thanks, Ali.

Ali Curi: And for our new listeners who have not met Bruce or Will, Bruce Roberts is responsible for Clear Derivatives at ION and Will Mitting is the CEO of Acuiti.

Bruce, let's start with you. ION has once again partnered with Acuity to produce a very informative report titled, _Retail Revolution: How retail brokers in Europe are planning to counter CFD restrictions and what that means for institutional markets._ Share with us an overview of what is happening with European CFDs that prompted ION and Acuiti to publish this report.

Bruce Roberts: Thank you, Ali. For those not familiar with CFDs, [00:02:00] it stands for Contracts for Difference and otherwise commonly called CFDs. The product's been popular in the EU for a period of time, but these are complex products and the EU has been increasingly warning that these are not suitable for all investors.

To explain in more detail, a CFD is an agreement between a buyer and a seller to exchange the difference between the current price of an underlying asset such as shares, currencies, commodities, indices, etc., and its price when the contract is closed. CFDs are also leverage products, so they offer exposure to the markets while requiring you to only put down a small margin or deposit of the total value of the trade, so they will allow investors to take advantage of prices moving up.

But taking long positions or prices moving down by taking short positions on the underlying assets. And when the contract is closed, you receive or pay the difference between the closing value and the opening value of the CFD and or the underlying asset. So if the difference [00:03:00] is positive, the CFD provider pays you, and if the difference is negative, you must pay the CFD provider.

CFDs might seem similar to mainstream investments, such as shares that we're all familiar with. They're very different, as you never actually buy or own the asset underlying the CFD. This really raises the broader question if other country regulatory authorities are going to do the same. And if so, the impact on retail brokers who have sizable businesses in CFD trading may see a switch to them moving into offshore offering futures and options to retail investors in Europe.

This is a new market in Europe as retail investors have been muted compared to futures and options retail investors in Asia and North American markets that have seen significant growth. 

Ali Curi: Now, you mentioned that retail trading of listed derivatives in Europe has been relatively muted compared to the U. S. What factors do you believe have contributed to this disparity in retail trading activity between the two regions? [00:04:00] 

Bruce Roberts: The two factors I would reference are that CFDs are illegal in the U. S., Hong Kong, and several other markets. The other principal reason is that due to their relative simplicity and also favorable tax treatment in several European countries including the UK that gained in popularity and took off. 

Ali Curi: We've already seen some changes in Europe's regulatory landscape for retail trading. For example, Spain's restrictions on retail clients. Can you tell us more about what are the key factors driving these restrictions on products like CFTs and others?

Bruce Roberts: The health warnings by the EU have been growing stronger. This has been driven by the ongoing effect of the financial crisis that even moderate returns on savings and investments have been more difficult to achieve with the ultra low interest rates that we saw post the financial crisis. So the EU saw an increase in retail investors trying to enhance their returns.

Many investors considered investing in complex [00:05:00] products that offer the opportunity to trade on leverage such as Contracts for Difference or CFDs. And despite being suitable only for professional clients or highly experienced retail investors who understood the product, CFDs were also advertised to inexperienced retail clients.

So the potential gains that may be advertised in a way that does not fully explain or give sufficient prominence to the risks involved in trading them. And generally the buying and selling of CFDs, especially when done online, it's not accompanied by investment advice. So it means that you, the retail investor, are really responsible for your own decisions to trade.

And based on the analysis by the regulator, to the investment returns by retail investors and complaints to losses, ESMA started to intervene. And the regulator passed two major legislative frameworks, the package, retail and insurance based products regulation, which came into force in 2018, some increasing transparency offerings [00:06:00] to retail investors to the health warnings on these products.

And this built on MiFID II, which granted new powers to local regulators to impose restrictions on products offered to retail investors. So this opened the door and last year in July 2023, the Spanish regulator then announced the ban on marketing CFDs in the country to investors as well as restrictions on the leverage that retail clients could be offered.

Ali Curi: A couple of things, how would these restrictions likely impact European retail trading landscape, and what are some potential consequences for both retail investors and brokers? 

Bruce Roberts: As highlighted by the research from Will and Acuiti, proprietary trading firms in Europe and indicated that 69 percent of firms thought that other EU countries would follow Spain by imposing greater restrictions on CFD trading and other leveraged products.

So the perception in the market is that these restrictions by the regulator are a key indicator of the direction of travel and the restriction of these across the [00:07:00] EU. So based on this, retail investors are going to need to consider other markets and products and futures and options fit into this category and Europe may see strong growth.

So the impact of retail clients move in the EU to futures and options will curtail revenues from retail brokers. And they'll be forced to make a decision.

Jocelyn: This episode is brought to you by ION. At ION, our clear derivative solutions automate your complete trade lifecycle and deliver actionable insights whenever and wherever you need them. We offer execution and order management, post trade processing, and a complete front to back business solution. To learn more, visit us at iongroup.com/markets, or email us at markets@iongroup.com. 

Ali Curi: Okay, great. Thank you, Bruce. Let's go over to Will and learn a little bit more about the research.

Hi, Will. 

Will Mitting: Hi, Ali. 

Ali Curi: Will, once again, a very informative report. [00:08:00] Let's discuss some of the other findings with restrictions on CFDs, retail brokers need to adapt their business models, obviously.

What can you tell us about what strategies were reported in your report that brokers are implementing to navigate this changing environment? 

Will Mitting: Sure, so I think the best way to understand it is the difference, or the different CFDs have for the business model of retail brokers compared to the institutional business model.

So CFD brokers effectively act as both the venue and the broker. So there were significantly higher margins and revenues emanating from CFDs for retail brokers than in other products and other areas. So obviously any curtailment of CFD trading or other retail products will clearly have a significant impact on their business models.

As a result, we found very high levels of concern about potential restrictions amongst European retail brokers. Response we picked up firms are clearly factoring this into their strategy planning, coming up with plan Bs. We found three core areas where the firms are planning to respond. 

One is growing [00:09:00] their retail, their CFD business in other markets.

Bruce mentioned CFDs are illegal in certain markets, but there's wide swathes of Asia where they are legal and actively traded. We also found firms are planning to expand into institutional markets and a related strategy to that was offering listed futures and options to retail clients. And we also found small numbers of firms were planning to offer derivatives clearing as well.

While I think this is only really an option for the largest retail firms. I think that the number of firms considering clearing will grow once they evaluate the economics of offering listed derivatives to both retail and institutional clients. 

Ali Curi: One of the things you mentioned is strategies reported is the potential for brokers to expand into institutional markets.

Is this a realistic shift? I mean, what challenges might they face as they compete with these established players? 

Will Mitting: I think it's very realistic. I think While the clearly, as mentioned before, there would be a significant shift in business model required and an adjustment to smaller commissions on each trade this huge potential [00:10:00] for retail brokers in institutional markets.

I think if you look at the nature of many of these retail brokers, they're digital natives with very advanced front end technology. You only have to look at the websites of some of the leading retail brokers and compare those to the institutional brokers to see the difference in how they're approaching the market and the technology they're using.

But I think the key point is, it isn't simply a case of cutting and pasting their models from the retail market to the institutional market. There are several different requirements covering regulatory requirements, different expectations from institutional clients compared to retail clients in areas like end of day statements and completely different risk management environment.

In addition for firms going into clearing, there's a whole new set of requirements covering capital regulations and technology that will come into play. 

Ali Curi: Okay, and let's look at the flip side. Given the potential increase in competition from retail brokers, what can you share about how institutional firms are preparing to adapt for this changing landscape?

Will Mitting: So I think one of the most interesting findings from this report [00:11:00] was how low the level of concern was amongst incumbent institutional firms about the potential competitive challenge that they'll face from any moves from retail brokers into institutional markets. These firms operate in an environment in which commissions are already under severe competitive pressure.

There's a significant understatement of the disruption that the retail brokers could cause if they move into institutional markets. But there's also an opportunity, I think, for institutional firms with an inflow of retail traders into futures and options in particular, in the so called "pro tail end of the market," the high end retail investors that will increasingly, when they come into the futures and options listed space, will look much more like the proprietary trading firms and proprietary traders today, professional traders at these firms serve. So I think there's clearly a competitive threat, but there's an opportunity, and I think obviously the overall pie will grow significantly. So the market's big enough for everyone, I think, and for the merging that we anticipate of the market, but there is a competitive threat that I think is underestimated today.

Ali Curi: Great. Will, thank you, [00:12:00] those are some great takeaways. Okay, Bruce, over to you. Let's talk about how firms are responding to these challenges. Some data from the report indicates that retail brokers are considering investments in technology, right? Of course, to facilitate their transition into institutional markets.

Could you discuss with us some specific technology that brokers might prioritize in their investment strategies. 

Bruce Roberts: It's been common for retail firms to build their own technology for trading. So as Will alluded to, when you look at their websites and their front ends, they're very sophisticated. And you observe this also with the mobile trading applications that are available and have been customized for trading and CFDs and warrants and other products, but if some of the retail firms start to adjust their business models and expand into clear derivatives, the ability to manage orders, their accounting, client reporting, and risk management are going to be high on the party list.

So the back office systems developed for futures and options also require significant investment in firms like us are offering off the [00:13:00] shelf and faster solutions that if you have a brand new clearing business, then the ability to provide trade processing, accounting, and reconciliations and client reporting with a pre configured solution is a real benefit.

I would suggest for anyone looking to move into the futures and options business to evaluate your time to market, to get up and running. How integrated the solutions are front to back and look at the products that are off the shelf. The other area I mentioned is risk management. So being able to monitor exposure to clients intraday on the retail side will be key.

So this entails having a real time risk system that firms can play in trades real time and calculate margin and collateral requirements for retail clients. So it's important to be able to do this pre and post trade. And finally, I would recommend assessing if you're implementing an open architecture that allows you to feed data into analytical tools to be able to data mine how your retail clients are trading in areas of growth or inefficiency in your business.

And this will provide you a competitive advantage in understanding your [00:14:00] retail clients, but also applying AI tools in the future. 

Ali Curi: And from a ranking perspective overall, which areas rank the highest in terms of where firms are planning to invest? 

Bruce Roberts: So the areas of highest priority are one, trading, retaining a retail trading flow and deciding based on the volume to work with an institutional broker or gain direct membership will be a key question.

The second is risk management, which is again based on calculating margin and calls for collateral to manage client risk intraday. And the next three areas are all those trade, which I referred to earlier on trade processing, accounting, reconciliations, and having an integrated front to back process so you can maintain scalability. 

Ali Curi: And based on the findings of the report, what do you see as the most significant implications for the future of retail trading in Europe?

Bruce Roberts: So it'll be interesting to watch the next two or three years in the EU and how futures and options grow. If we look at Asia and North America [00:15:00] with the phenomenal growth of retail volumes in listed derivatives, it's more than likely a good indicator of what to expect in Europe. So the impact of this will be a pivot by a number of retail brokers to expand their services into listed derivatives, but also to move into other regions.

So this change will also bring more competition to existing institutional brokers. 

Ali Curi: And Will, along the same lines of Bruce's question, are there any key takeaways or predictions that you believe are essential for stakeholders in the industry to consider as they move forward? 

Will Mitting: I think the main takeaway is just the size of the opportunity for Europe's derivatives markets to grow if they can successfully capture retail trading.

It's not a foregone conclusion, there are barriers. If you look at the U. S. market, there's been a huge educational effort from led by the OCC and some of the exchanges to educate retail traders and facilitate their trading. There's also areas like market data fees that need to be rationalized for a retail market.

So I think the opportunity is [00:16:00] there. It's within our grasp, but there are steps that need to be taken in order to realize that opportunity. 

Ali Curi: Great. Now I want to hear both your takes on the following questions. So from a big picture standpoint, what's the one big thing you hope listeners will take away from this episode?

Bruce, let's start with you. 

Bruce Roberts: The market's constantly adapting and the unintended consequences of the financial markets crisis back in 2008-10 continues to play through the financial markets in Europe with clients trading CFDs, warrants, and other products and as the regulator has been signaling more significant actions, it is important to watch the warning lights as you progress down the road and read the signs to the impact this will have.

Will, what are your thoughts? 

Will Mitting: I think that's right. With regards to regulation, as you alluded to the beginning, one of the factors that regulators have looked at is the risk of loss that the retail investors face. But I think probably the bigger issue is the counterparty risk. So I think one thing that listeners should take away is the view that trading enlisted markets for [00:17:00] retail traders is a better environment.

It's a less risky environment, and I think regulators in particular need to heed that. Retail traders will trade, it's in their DNA, they should be allowed to trade, they should be allowed to trade products that offer them, not necessarily a low risk of loss because that, that's part of the game, but a low counterparty risk, and listed derivatives fulfill those requirements.

Ali Curi: Thank you, Will. Also, Will, where can people find the report that we've been discussing today? Because there's so much more in there that our listeners can learn from. 

Will Mitting: So the report's available to download from our website, www.acuity.io. There's no cost to download it.

Ali Curi: Great. Bruce, I've asked you about career advice in previous episodes, but my question for you, I'm keeping it fresh, my question for you today has to do with the future. So Bruce, what legacy do you hope to leave behind? What are you doing to work towards it? 

Bruce Roberts: Great question Ali. From my own personal wish is to have helped the futures industry to become more resilient, efficient, and effective in the support of the market and [00:18:00] participants through the development of the technology that's used.

We will hopefully have left a stronger foundation to those who've come after us and have been good stewards. 

Ali Curi: Thank you. And Will, same question. What legacy do you hope to leave behind and how are you working towards it?

Will Mitting: I'm just trying to get in and out, causing as little damage as possible on the way, Ali.

Ali Curi: Sounds like a great goal for a legacy. Bruce Roberts and Will Mitting, thank you both for joining us again on the podcast. 

Bruce Roberts: Thank you again for hosting us, Ali. We look forward to the next visit. 

Will Mitting: Thanks, Ali. Been a pleasure as always. 

Ali Curi: And that's our episode for today. You can follow ION Markets on X and LinkedIn.

Thank you for joining us. Until next time.