Britain's financial watchdog has joined other European regulators in a crackdown on financial spread betting, a fast-growing 3.5 billion pound ($4.5 billion) industry where most retail investors lose money.
The Financial Conduct Authority (FCA) said it had found evidence of poor conduct across the market over the past six years and that people using the most popular financial betting product - known as a contract for difference (CFD) - lost 2,200 pounds ($2,805) a year on average.
"We have serious concerns that an increasing number of retail clients are trading in CFD products without an adequate understanding of the risks involved," the FCA's Executive Director of Strategy and Competition Christopher Woolard said.
Shares in Britain's major financial betting firms lost more than a quarter of their value on Tuesday and lawyers said the FCA proposals were much tougher than expected.
IG Group, which has 40 percent of Britain's financial spread betting active accounts, fell more than 30 percent, making it the biggest loser across major European stocks. Rivals CMC Markets and Plus500 posted similar falls.
In recent months, France has moved to ban digital advertising of CFDs and the Netherlands is considering a similar measure, Belgium has banned CFD trading and Germany could "intervene shortly", Numis analysts said, highlighting the regulatory risks faced by the sector.
The spread betting industry in Britain has grown rapidly and there are about 125,000 retail customers in the country trading CFDs. There are 97 CFD firms authorised by the FCA, double the number six years ago, and they also serve some 400,000 retail clients outside Britain. Another 130 firms, mainly based in Cyprus, offer CFDs to clients in Britain.
CFDs let investors bet on both the direction a share price, currency or other financial product will move, and the extent of the change in price, and there is no stamp duty.
The industry is regulated by European Union rules which have no caps on leverage. That means investors can take out bets that are far larger than their initial outlay, offering greater potential returns but also running the risk of huge losses.
The FCA wants to split the retail CFD market into two categories: people with little experience and more experienced investors. Under the first category, the exposure taken on must not be greater than 25 times the initial outlay, and it would be capped at 50 times for the second group. Under current rules, some firms have been offering leverage of up to 500:1.
The watchdog also wants to ban "bonuses" to entice new investors. It wants the measures in place by mid 2017 and believes they will reduce losses for retail investors by 20 percent to 40 percent.
Lawyers said the FCA was taking a very protectionist approach as many retail investors probably understood the risks.
"This is less an example of 'conduct regulation', rather, 'product intervention', and this will come as a shock to the UK industry, which received detailed briefings from the FCA earlier in this year where this was not indicated," said Jake Green, a regulation partner at law firm Ashurst.
IG Group said some of the FCA's proposals could "enhance client outcomes" but noted they did not appear to apply directly to firms outside Britain offering CFDs.
CMC Markets said it already focused on "higher-value", experienced clients who understood the products. Plus500 said the proposed measures would affect about a fifth of its revenue.
Cyprus's financial regulator CySEC issued a warning last week to retail currency brokers registered on the island over their use of bonus schemes to encourage trading in risky products and their poor treatment of clients.
"FCA seems to be imposing more penal rules than the Cypriot regulator last week ... This will result in a much smaller, less profitable CFD and spread betting industry," said Liberum analysts.
The FCA also said it would look at new rules for binary options - a product that lets people take a position on a price movement in a fixed time frame - once it assumes regulatory responsibility for them from the UK's Gambling Commission.
(For a Reuters special report on binary options, click on: here)
($1 = 0.7844 pounds)
(Reporting by Huw Jones in London and Noor Zainab Hussain in Bengaluru; editing by Louise Heavens and David Clarke)