CFD trading – Trading contracts for difference (CFDs) has become increasingly popular in recent years. However, trading CFDs also involves considerable risks and is legally complex. In this article, you will learn everything you need to know about the Herfurtner law firm and its expert legal advice.

We go into the legal basics of CFD trading, highlight the risks and opportunities of CFDs and explain how you can benefit from the experience of our CFD trading lawyers.

Table of contents

  1. What are CFDs?
  2. How does CFD trading work?
  3. Choosing a CFD broker
  4. Legal basics of CFD trading
  5. Risks and opportunities of CFDs
  6. Legal advice and representation for CFD trading
  7. Do you need help?

What are CFDs?

CFDs (Contracts for Difference) are financial instruments that allow investors to speculate on the performance of underlying assets such as shares, indices, commodities or currencies without owning them themselves. The investor and the CFD provider (broker) agree to settle the difference between the buy and sell price of the underlying asset at the end of the trade.

Depending on whether the price has risen or fallen, the investor receives a profit or suffers a loss. The legal aspects of CFDs are briefly explained below.

Legal classification of CFDs

CFDs are defined as financial instruments within the meaning of Section 1 (11) of the German Banking Act (KWG) and as derivatives within the meaning of Section 2 (3) of the German Securities Trading Act (WpHG). Accordingly, they are subject to regulation by the German Federal Financial Supervisory Authority (BaFin) and must comply with the provisions of the KWG, WpHG and the EU Markets in Financial Instruments Directive II (MiFID II).

This directive aims to strengthen investor protection, promote competition in trading and ensure market integrity.

Obligations of CFD providers

CFD providers are required to hold a license from BaFin and comply with the following regulations:

Minimum capital requirements: CFD providers must have sufficient capital to cover potential losses and ensure the stability of the business.

Risk management: Providers must have adequate risk management systems in place to manage market risks, liquidity risks and operational risks.

Business organization: CFD providers must have an appropriate business organization to ensure that they conduct their business properly and protect the interests of investors.

Investor protection: Providers are obliged to inform investors about the risks of CFD trading and to take appropriate measures to protect their interests.

Transparency: CFD providers must provide transparent and understandable information about the trading conditions, costs and fees as well as the possible risks.

How does CFD trading work?

This chapter explains the CFD trading process. CFD trading is based on leverage, which allows the investor to take a larger market position with a small capital investment. The profit or loss from CFD trading results from the difference between the buy and sell price of the CFD contract.

Account opening and identity verification

In order to trade CFDs, an investor must first open a trading account with a CFD broker. Legal regulations must be observed:

  • The broker is obliged to verify the identity of the investor as part of the legal provisions to combat money laundering and terrorist financing (know-your-customer principle). In Germany, this is done in accordance with the Money Laundering Act (GwG) and the corresponding EU directives.
  • The investor must provide the broker with the necessary personal data and documents, such as a copy of the identity card or passport and proof of residence.

Risk disclosure and suitability check

Before CFD trading, the investor must be informed about the risks associated with trading:

  • The broker is legally obliged to provide the investor with comprehensive information about the risks of CFD trading in accordance with Section 63 WpHG and the MiFID II Directive.
  • The broker must also check whether the investor has sufficient knowledge and experience to understand and assess the risks of CFD trading. This takes the form of a suitability test in accordance with Section 64 WpHG and the MiFID II Directive.

Trading with CFDs

  • As soon as the trading account has been opened and the legal requirements have been met, the investor can start trading CFDs:The investor chooses an underlying asset (e.g. a share, an index or a commodity) and decides whether to speculate on a rising (long position) or falling (short position) price.
  • Trading is carried out on margin, i.e. the investor only deposits a fraction of the actual trade value as collateral with the broker. Margin requirements are regulated by law and vary depending on the underlying asset and broker.The CFD contract is concluded between the investor and the broker and reflects the difference between the buy and sell price of the underlying asset.

Profits, losses and margin calls

Depending on the performance of the underlying asset, the investor can make profits or suffer losses:

  • If the speculation is successful, the investor receives the difference between the buy and sell price of the underlying asset as a profit.
  • In the event of an incorrect speculation, a loss is incurred in the amount of the difference between the buy and sell price.

Closing the position and payout

Investors can close their CFD position at any time during trading hours:

  • The position is closed either manually by the investor or automatically by the broker when a predetermined price target is reached or the margin requirements are no longer met.
  • After the position is closed, the profit or loss is credited or debited to the investor’s trading account.
  • The investor can withdraw available capital at any time, provided this complies with legal requirements and the broker’s terms and conditions.

Choosing a CFD broker

Choosing a CFD broker is a crucial step for investors in CFD trading who want to start trading contracts for difference (CFDs). In addition to economic aspects, legal aspects are also of great importance when choosing a suitable broker. The most important legal criteria and aspects when choosing a CFD broker are discussed below.

1. regulation and authorization of the CFD broker

  • One of the most important legal requirements for a reputable CFD broker is appropriate regulation and authorization by a financial supervisory authority. In Germany, the Federal Financial Supervisory Authority (BaFin) is responsible, while in other European countries such as the UK, the Financial Conduct Authority (FCA) is responsible.
  • Make sure that the CFD broker has a valid license from a recognized financial supervisory authority. You can usually find information about the license on the broker’s website or on the website of the responsible authority.
  • Make sure that the broker meets the legal requirements of the country in which it operates. This includes compliance with the German Banking Act (KWG), the German Securities Trading Act (WpHG) and the European MiFID II Directive.

2. Deposit protection and investor protection

  • Another important legal aspect when choosing a CFD broker is the protection of customer deposits. In the European Union, CFD brokers are obliged to protect their customers’ deposits up to a certain amount.
  • Before CFD trading, check whether the broker is a member of a deposit protection scheme that protects your deposits up to a certain amount in the event of the broker’s insolvency. In Germany, for example, these are the Compensation Scheme of Securities Trading Companies (EdW) or the Deposit Protection Scheme of the Association of German Banks.
  • Make sure that the broker provides clear information about the protection of customer deposits and what amounts are protected in the event of insolvency.

3. transparency and fair terms and conditions

  • A reputable CFD broker should offer transparent and fair terms and conditions that comply with legal requirements and take the interests of investors into account appropriately.
  • Check the broker’s terms and conditions for inappropriate clauses, which may contain unjustified fees or inadequate risk disclosures, for example.
  • Make sure that the broker provides clear and understandable information about costs, fees, margin requirements and possible margin calls.
  • Ensure that the broker has transparent pricing and does not apply hidden costs or unjustified spreads.

4. customer support and complaint management

  • A reputable CFD broker should offer effective customer support and complaint management to avoid or at least minimize legal disputes.
  • Check whether the broker is easy to contact and whether it has qualified staff who can assist with legal questions or problems.
  • Find out about the options for submitting complaints and make sure that the broker offers transparent and efficient complaints management.

Legal basis of CFD trading

Trading CFDs is subject to various legal regulations and provisions in Germany. The most important legal principles of CFD trading are explained in detail below.

German Banking Act (KWG)

The German Banking Act (KWG) regulates the licensing and supervision of financial services institutions in Germany. As CFDs are considered financial instruments within the meaning of Section 1 (11) KWG, CFD providers must be licensed by BaFin in order to offer their services in Germany. They are also subject to the regulatory requirements of the KWG, such as minimum capital requirements, organizational requirements and reporting obligations.

Securities Trading Act (WpHG)

The German Securities Trading Act (WpHG) is the central set of regulations for trading in securities and derivatives in Germany. CFDs are considered derivatives within the meaning of Section 2 (3) WpHG. CFD providers must therefore comply with the provisions of the WpHG, in particular with regard to the prevention of market abuse, the provision of information to investors and compliance with rules of conduct.

MiFID II (Markets in Financial Instruments Directive II)

The EU directive MiFID II is another important set of regulations for CFD trading. It aims to strengthen investor protection, promote competition in trading and ensure market integrity. CFD providers must therefore comply with the provisions of MiFID II, for example with regard to the best execution policy, the transparency of prices and fees, the disclosure of risks and the recording of communications with clients.

General Terms and Conditions (GTC) and contract law

The contractual relationship between investors and CFD providers is governed by General Terms and Conditions (GTC). These must be drafted in accordance with German contract law, in particular the German Civil Code (BGB). Inadmissible or unclear clauses can be declared invalid by the courts. Investors should therefore check their contracts and GTCs carefully and seek legal advice if in doubt.

Outlook and possible legislative changes

Due to the high risks and the increasing popularity of CFD trading among private investors, further regulatory measures and legislative changes are conceivable. For example, the introduction of a financial transaction tax on derivatives, as is being discussed in some EU countries, could affect CFD trading. In addition, stricter requirements for risk disclosure and the business practices of CFD providers could be introduced in order to further strengthen investor protection.

Risks and opportunities of CFDs

Trading CFDs involves both opportunities and risks. These aspects are explained in detail below in order to provide a comprehensive understanding of the legal framework and implications.

Opportunities of CFDs

  • High potential returns: CFDs offer investors the opportunity to achieve high returns as they can profit from price movements of various underlying assets without actually having to own them.
  • Leverage effect: CFDs allow the use of leverage, which means that investors can achieve high profits with a low capital investment. Leverage amplifies both profits and losses and makes it possible to take large positions with a small margin (security deposit).
  • Flexibility: CFDs are flexible and can be bet on rising or falling prices, allowing investors to profit in different market phases.
  • Access to different markets: CFDs allow access to a variety of markets, including shares, indices, commodities and currencies, providing diversification opportunities for investor portfolios.

Risks of CFDs

  • High volatility: The prices of the underlying assets on which CFDs are concluded can fluctuate significantly. This increases the risk of losses for investors when trading CFDs.
  • Obligation to make additional contributions: In the case of leveraged positions, the margin may not be sufficient to cover the losses. In such cases, the CFD provider may impose a margin call, whereby the investor must inject additional capital. Since August 2017, however, margin calls have been prohibited for private investors in Germany.
  • Total loss of invested capital: In the worst-case scenario, trading CFDs can lead to the total loss of the invested capital, especially if high leverage is used.
  • Low regulation in some countries: In some countries, CFD providers are less heavily regulated, which increases the risk of fraud and unfair business practices.

Legal framework and investor protection

In order to minimize the risks of CFD trading for investors, legislators and supervisory authorities in Germany and the EU have taken various measures:

Ban on margin calls: As already mentioned, BaFin issued a general ruling in August 2017 prohibiting CFD providers from requiring private clients to make margin calls.

Stricter information requirements: CFD providers must provide investors with comprehensive information about the risks of CFD trading to ensure that they are aware of the potential losses. This also includes information on the use of leverage and the possible consequences.

Product interventions by ESMA (European Securities and Markets Authority): In 2018, the European Securities and Markets Authority (ESMA) introduced temporary measures to restrict the sale, marketing and distribution activities of CFDs to retail clients. These measures include leverage restrictions, margin protection rules and a standardized risk warning.

Consideration of suitability and appropriateness: CFD providers must take into account the financial situation, investment objectives and experience of investors to ensure that the products offered are suitable and appropriate for them.

Legal advice and representation for CFD trading

A lawyer can help you understand your legal rights and obligations in relation to trading contracts for difference, review and amend your contracts and terms and conditions if necessary, and provide legal support in the event of disputes with CFD providers or other market participants. The various aspects of legal advice and representation in the area of CFD trading are explained in more detail below.

Review of contracts and terms and conditions

A CFD trading lawyer can assist you in reviewing contracts and terms and conditions to ensure that they comply with the law and that your interests as an investor are adequately considered. Among other things, the following aspects will be reviewed:

  • Compliance with applicable laws and regulations: The lawyer ensures that the contracts and terms and conditions comply with the requirements of the KWG, WpHG, MiFID II and other relevant laws and regulations.
  • Transparency and comprehensibility: It is checked whether the contracts and terms and conditions are formulated clearly and comprehensibly and do not contain any inappropriate clauses.
  • Risk disclosure: The lawyer checks whether the disclosure of the risks of CFD trading, such as possible total losses, is sufficient and comprehensible.
  • Leverage and margin requirements: The lawyer checks whether the rules on leverage and margin requirements are appropriate and comply with the law.

Legal advice in the event of disputes and claims for damages

If disputes or claims for damages arise in connection with CFD trading, a CFD trading lawyer can support you in enforcing your rights. This may be the case, for example, if

  • A CFD provider has not adequately informed you about the risks of CFD trading.
  • A CFD provider has closed your positions at unfavorable prices.

Inadmissible contractual clauses are contained in the CFD provider’s terms and conditions.

In such cases, the lawyer will investigate your claims, gather evidence and, if necessary, take legal action to claim damages.

Representation in regulatory investigations and sanctions

A CFD trading lawyer can also represent you in regulatory investigations and sanctions by supervisory authorities such as BaFin or ESMA. This may be the case, for example, if a CFD provider has violated legal regulations or if the supervisory authority is conducting an investigation into the provider’s business practices.

In such cases, the lawyer will support you in communicating with the supervisory authorities and ensure that your rights are safeguarded. The following aspects, among others, will be taken into account:

  1. Educating you on regulatory requirements: The lawyer will help you understand the applicable legal requirements and regulatory requirements and act accordingly.
  2. Defense against sanctions: Should sanctions such as fines or trade restrictions be imposed on you, the lawyer will examine the reasons for this and, if necessary, file an appeal or take further legal steps to avert or reduce the sanctions.
  3. Cooperation with the supervisory authorities: The lawyer will ensure that communication and cooperation with the supervisory authorities runs smoothly and that all necessary documents and information are provided.

Preventive advice and training

To avoid potential legal issues related to CFD trading, a CFD trading lawyer can also provide preventative advice and training. This can include, for example, the following aspects

  • Development of compliance guidelines: The lawyer will help you develop internal policies and procedures to ensure that your business complies with legal requirements and regulatory requirements.
  • Employee training: The lawyer can provide training for your employees to educate them on the legal aspects of CFD trading, the applicable laws and regulations, and the associated risks and opportunities.
  • Ongoing advice and updates: The lawyer will be available to provide ongoing legal advice and keep you informed of changes in the law or new regulatory requirements that may be relevant to your business.

Do you need help?

Trading CFDs involves both opportunities and risks and is subject to a wide range of legal regulations. Investors should inform themselves comprehensively about the legal aspects of CFD trading and, if necessary, seek professional support in order to protect their interests in the best possible way.

If you have any questions about CFD trading or need legal advice and representation in this area, please do not hesitate to contact our law firm.