Why did Plus500 Ltd and CMC Markets plc crash by a third today?
Shares in Plus500(LSE: PLUS) and CMC Markets(LSE: CMCX) have plunged by as much as 30% in early deals this morning after the Financial Conduct Authority announced that it's planning to impose stricter rules on the contracts for difference (CFD) market after identifying a number serious concerns.
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The FCA's announcement comes after a year-long consultation on CFD products, which itself followed work over the last six years on the market for these products. The regulatory agency found that firms are failing to adequately consider if CFDs are appropriate for their customers and are failing to provide adequate risk warnings. What's more, the FCA believes firms are offering excessive levels of leverage to retail clients with CFD products.
Reforms ahead
As part of the package of market reforms the FCA is proposing to meet its concerns after the review, the regulator is looking to force CFD providers such as CMC and Plus500 to set lower leverage limits for inexperienced retail clients with a maximum of 25:1, and cap leverage at a maximum level of 50:1 for all retail clients. This proposed rule change is particularly damaging for Plus500, which has come under fire in the past for the high leverage ratios it offers to new customers.
The FCA is also looking to prevent providers from using any form of trading or account opening bonuses or benefits to promote CFD products. Both CMC and Plus500 have used bonuses in the past to attract clients.
Stormy waters ahead
Unfortunately, CMC and Plus500 are more exposed to these proposed changes than their larger peer IG Group. You see, IG is one of the biggest trading institutions in London and around the world. The group has worked hard to diversify its offering to clients. CMC and Plus500, on the other hand, are still growing.
Plus500 is generally considered to be at the low end of the retail spread betting and CFD market. Customer churn is higher and the company has attracted plenty of criticism in the past not just for the high levels of leverage it offers to customers but also for its aggressive marketing tactics. Analysts have not yet had time to fully analyse the rules and the impact they will have on the two firms but City broker Numis has already warned that the changes are "likely to have a material impact, at least in the near-to-mediumterm, on CMC's growth and profitability across the UK and Europe."
The bottom line
Until there's more clarity on these rules and how they will affect the individual business models of CMC and Plus500 it might be best for investors to stay away from these companies. The rules are unlikely to push them out of business overnight, but growth and profitability will likely be severely impacted.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
