I'm struggling to understand why the risk on an equity CFD is not the same as for the corresponding equity. The RiskMetrics FAQ mentions two ways to model a CFD, but it does not explain why this is necessary. A good explanation would be appreciated.
Can you point to a source saying that the risks really are different? See the risk section of the wikipedia page. The market risk of an equity CFD and the corresponding equity should be the same. A CFD trader also faces additional liquidation (leverage) risk and counterparty risk, which an ordinary unlevered equity trader does not. There are also a few other differences in risk due to corporate actions (dividends). Once again, the wikipedia page explains everything here.
My impression is that CFDs are functionally equivalent to futures, except that they are traded OTC and have smaller contract sizes.