Contracts for difference are a relatively new product that enables an investor to bet on the movement of a share. They were first used in a big way in the early 1990s in the Trafalgar House’s takeover of Northern Utilities, when it was used by the takeover team as a way of funding the bid. Effectively the cash performance notes, as the contracts for difference were more commonly called then, were made so that a big leveraged bet could be made on the increase in the share price of other utility companies. As all the utility companies saw their price rise, so the value of these contracts for difference also rose.
In a takeover bid it is necessary for the parties to disclose their positions in other firms so that conflicts of interest are clear, but as the contracts for difference were not actually a derivative of the shares, but simply a contract with another trader, this was not the case. The Takeover Panel later changed the rules to make this practice illegal.
However the value of contracts for difference were soon clear to hedge funds and other investors who now saw a cheap way to offset their exposure to some shares. They also had enough distance from the underlying share that they did not need to pay stamp duty. Throughout the 1990s it became more common to use contracts for difference.
