TThe application of CFDs first became widespread in the UK equity market in the early 1990s, the driving force being a requirement by non market-makers to be able to short stock (sell shares they did not own).
At that time only market makers, most of whom were integrated within big investment banks, were able to do this. So the investment banks became natural CFD providers, while typical users included hedge funds, arbitrageurs and funds pursuing market-neutral strategies. Demand then evolved to encompass long contracts as well as short, as no stamp duty was payable on these transactions because no actual stock transfer took place. Although CFDs confer no ownership rights such as a shareholder vote, they do reflect the full performance of the stock including dividends and corporate actions such as share splits, and for many users (including short-term traders) these are the features that are paramount.
At this point it is important to grasp the concept of CFD trading. Most CFD providers choose to hedge all CFD transactions that they undertake with clients in the underlying UK stock market. There is a common misconception that when you wish to execute a long CFD in, say, Vodafone Group, that you need to find a seller of the CFD, and similarly, when you wish to close the trade you need to find a buyer. This isn't what happens; the CFD provider simultaneously hedges himself by buying Vodafone in the marketplace, so CFD liquidity is purely a reflection of the liquidity in the underlying stock and CFD transactions can be almost instantaneous.
With the introduction of the SETs system to the UK market in 1997, stamp duty exemption was widened to recognised liquidity providers who were members of the Stock Exchange and it is these members who now provide the retail CFD product.
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