Derivatives: introduction to Contracts for Difference: hedging a Contract for Difference
There is a degree of risk or exposure for the writer or issuer of a Contract For Difference (CFD) as he will not generally know the future direction of a Market securities price as a CFD’s performance is based on (or derived from) the movement of the price of an underlying asset.
In this situation a provider (such as a broker) of a CFD can minimise their risk or exposure by purchasing a sufficient quantity of the underlying shares, usually at the time of CFD issue.
This mechanism of minimising risk is called hedging.
The acquisition by the issuer/writer of the CFD of UK ‘chargeable securities’ as a hedge will represent an agreement to transfer for the purposes of a charge to SDRT (under FA86/S87), unless the issuer is, say, a recognised intermediary eligible for relief.
See STSM042050 for details of intermediary relief.
In a Parliamentary Answer on 21 March 1997 the then Economic Secretary to The Treasury explained that where ‘a dealer buys and holds shares merely to hedge derivative contracts [for which a CFD is a form of derivative] which it has made, that would not be regarded as a business of making investments for the purposes of the excluded business test’. STSM042080 provides fuller details of the Parliamentary Answer.
See STSM031090 for the meaning of chargeable securities.