Last September, an independent government review of the circumstances surrounding the collapse of Football Index found failing both in the actions of the Gambling Commission and the Financial Conduct Authority (FCA), the UK’s financial regulator.
The GC had some concern that, due to changes made by the management of Football Index, the product was possibly a financial instrument and should have been regulated by the FCA. The FCA did not respond in a timely fashion and when the GC did react, it was too late for Football Index, which collapsed into bankruptcy.
The independent review has resulted in a strengthened memorandum of understanding between the GC and the FCA, which includes promises of better cooperation.
Why didn’t the FCA respond in a timely fashion? It is my belief that the FCA did not want to go anywhere near anything that even has the slight whiff of gambling about it. For the past 150 years, the London Stock Exchange and the financial sector have fought hard to ensure that the financial transactions are not perceived as gambling.
They believe that if the activity on the Stock Exchange and other financial markets is perceived to be nothing more than gambling, it would undermine the integrity of those markets. This is ironic when you consider that the vast majority of activity that FCA regulates is, in fact, gambling.
So then, what is the difference between gambling, speculation, and investing?
I have scoured the internet looking for clarification, but from what I can find, from the financial markets’ perspective, gambling is “when a person gives money specifically for the mere chance of receiving more money”. Yes, and so is investing. It is a rare investor who makes an investment in the hope that he or she will receive less money.
Also, financial professionals say that investment is done with research and knowledge of a particular financial product or sector, is long term, and it is very unlikely that the investor will lose all the money. Yes, and plenty of bets out there will nearly always return something to the bettor. Many people make bets with research and knowledge and still lose money, and I know of cases where people have “invested” in the financial markets and have lost all of their money. So I do not think this is an apt distinction.
Some investors, like Berkshire Hathaway, look for value, in their view an under-priced asset, and invest accordingly. But this is no guarantee; there is still a risk that the market will move against them and they will lose money. After all, markets move according to investor sentiment, which only sometimes includes the fundamental performance and outlook for a particular company.
Ever since the London Stock Exchange (LSE) was founded in 1801, they have struggled with the distinction between investing, gambling, and speculation. Whether or not the LSE described the buying and selling of various financial instruments as gambling, speculation, or investing very much depended on the social and political mores of the time.
In the early 1800s, speculation and gambling on stocks and shares to make money was not seen as a bad thing. Interestingly, in 1829, a group trying to legalise betting on horseracing used the similarity of the activity in the stock market to betting on horses as an argument for legalisation.
By the mid-1800s, there were a few well-publicised speculative bubbles in which people lost a great deal of money. The most famous was the Great Railway Bubble. Parliament passed laws authorising a large number of new routes and companies were rapidly formed to take advantage of this opportunity. Large amounts of capital flowed in, share prices inflated dramatically, more capital poured in, and tracks were built. But insufficient demand for the new tracks ultimately led the share prices to collapse.
This scandal led to speculation being considered nothing more than gambling, which should be eradicated. However, there was a great deal of snobbery about who should be able to buy and sell shares. The attitude of the Stock Exchange was that the activity of those with little money, i.e., “the small investor,” was seen as gambling and speculation and should be deterred. Whereas the rich were sophisticated investors, so their money was acceptable.
Late in the 19th century, accusations of fraud in the financial markets by people who had lost money (and probably had been defrauded) led to a Royal Commission being appointed to investigate these accusations. The Commission found no fault with the Exchange; instead, it blamed “people of limited means” who lost their life savings for “bringing the financial markets into disrepute”.
Religious opposition to the making of money for money’s sake in Victorian Britain put investing in the dock. The Exchange quickly scrabbled around to make it known that there was now a big difference between investing, which was for the public good, and speculation and gambling, which was bad.
Through a variety of means, poorer people were excluded from the Exchange; only those with “sufficient capital” were allowed to buy and sell shares. Because those without sufficient capital were unable to buy stocks and shares, it led to the rise in the number of “bucket shops”, places where they could bet on whether stocks and shares would fall or rise over a period of time, not unlike a Contract for Difference today. At one point, there were more than 130 bucket shops in the financial district of London.
By arguing that investments from rich people was not speculation, the powers that be in the financial community had successfully distanced themselves from the accusation that the financial markets were gambling and speculation. They saw no parallel between the activities in the financial markets and that which went on in the bucket shops.
Even so, some financial experts continued to explain in marketing materials that “investment and speculation are twin sisters, and so nearly alike it is almost impossible to discriminate between them”! But the financial community made it clear that speculation should be carried out only by the “professional speculator”.
The amateur speculator was considered of “flabby character” who likely had “a taste for the excitement of dabbling in the markets”, which “grows into a thirst and then into a mania”. These amateurs had to be excluded in order for professional speculation to be publicly acceptable.
The war years in the early to mid-20th century encouraged everyone to become investors. The government needed to sell war bonds and buying them was considered a patriotic duty.
Post WWII, as the country became more liberal, economists and politicians argued that the buying and selling of shares should be democratised. But in order for this democratisation to occur, they needed the small investors’ actions to be free from accusations of speculation or gambling. A clear demarcation was needed.
Investors were described as thoughtful and dealing in certainties (!), whereas speculators were knowing risk takers, but sought to reduce their risk, and gamblers risked all based on gossip and had no understanding of what they were buying or selling.
In order to attract the small investor, but to make sure that “speculators” and “gamblers” (i.e., small investors) were discouraged, the Exchange ensured that there were high fixed commissions on each market transaction, but allowed unit trusts (mutual funds) to trade on their Exchange.
Managers of these funds were considered “professional investors”; thus the small investor was one step removed from the buying and selling of shares. Nobody could accuse the Exchange of fostering gambling or speculation.
Today, in addition to stocks, shares, bonds, and unit trusts, we have a seemingly endless number of products that can be traded (CfDs, options, futures, swaps, and other derivatives). Numerous entities such as investors, mutual funds, hedge funds, high-frequency traders, day traders, etc. all believe they have the secret sauce to make money in these markets. Until they don’t.
Despite the financial industry’s declarations, the line between investment, speculation, and gambling is very thin indeed.
