Contracts for Difference Trading in Australia


CFDs in Australia


Contracts for difference have been available to Australian investors since 2003. In this time they have completely changed what it means to be a trader or speculator in many different investments. In fact, over this relatively short period, they have been adopted by both newcomers to trading as well as existing traders who have switched from other trading products. Previously, most share market speculators in Australia dabbled in penny shares but CFDs have now given them access to much higher priced shares which are no longer the preserve of longer term investors who traditionally buy into these companies for their dividends and long term capital growth potential. Contracts for difference in Australia have become one of the fastest growing financial products in history outstripping the growth seen in warrants in the 1990's.

Origins and Present Day

Originally CFDs first appeared in Australia in March 2002 when CMC Markets entered the market followed closely by IG Markets in July 2002, three years after their introduction in Britain and now have become one of the fastest growing financial products to enter the Australian market place.

The popularity of CFDs reached a peak in 2007 and due to their rapid uptake by Australian traders and investors a number of foreign CFD providers set up branches in Australia. CFDs are today big business in Australia with industry estimates suggesting that in 2015 there were 49,000 active CFD traders in Australia (according to an annual report by research firm Investment Trends Report). In 2016, this number dropped to 37,000 active traders. Originally in 2005 there were only 9000 CFD traders and this number climbed to 32,000 in 2009 and to 39,000 in 2010.

# of Active CFD Traders in Australia
YEAR # of Traders
2014 42,000
2015 43,000
2016 37,000

So why has the growth stalled at 37,000 active traders in 2016? This could be attributed to two factors; one was the market turbulence - volatility does create opportunities and encourage investors to trade more frequently but if volatility is too much, it could also drive more traders to remain on the sidelines. Secondly, ASIC regulations are becoming more honerous and some foreign providers have exited the Australian market.

CFD Market by Country
COUNTRY # Active CFD Traders # Active Online Share Trader Penetration Rate
UK 89,000 810,000 10%
Germany 50,000 990,000 5%
Australia 37,000 605,000 6%
Spain 27,000 350,000 8%
France 19,000 570,000 3%
Singapore 18,000 240,000 8%

CFDs are today big business in Australia with industry estimates suggesting that there are more than 39,000 Australians currently trading the instruments (according to the fifth annual May 2010 CFD report by research firm Investment Trends). According to Investment Trends figures, Australia's CFD market is valued at around $350 million with the number of investors climbing up from 9000 in 2005 to 32,000 in 2009 and to 39,000 in 2010. Presently it is thought that there are some 41,000 traders (2011)and this figure keeps rising. In 2005 there were only 9000 traders, so the number has increased more than fourfold.

The report attributed the growth to a combination of new traders and a large number of dormant traders returning to the market. In fact, an additional substantial number of investors have indicated that they intended to commence CFD trading within 12 months. At present it is thought that there are over 35 CFD companies operating in Australia although the lion share of the market is held by the the original players, IG Markets and CMC Markets.

Most of the trading doesn't take place on the Australian Stock Exchange per se' but on what are termed over-the-counter markets so the usual rules as laid down by the ASX do not apply. Investors can buy on large margins (that is, with little equity -- perhaps 5 per cent) and can buy and sell without the full sale price being transferred. Instead, the profit from the transaction is added to their balances, or the loss subtracted.

In Australia CFDs are provided by 5 primary providers who run their own trading platform: IG Markets, CMC Markets, City Index and Macquarie Bank. Macquarie offers CFDs through Macquarie Prime, its all-in-one service that brings together stockbroking, margin lending, stock lending and CFD trading.

There is also a larger group of 'white-label' providers, which re-badge another company's platform.

White-label providers include CommSec, Adest Trader, Marketech, WealthWithin, Halifax Futures, GET Futures, Spectrum Live, ProTrader, Tolhurst Noall, GT Financial, VBM Capital, Capital Markets Group, Pacific Investments Group and First Prudential.

The market leader is thought to be IG Markets which offers both a direct market access and market-maker platform and which commands a 34% (2010: 29%) market share and accounts for about 15% of group revenue [IG Group]. IG Markets was set up in Australia seven years ago and has about 70 staff in Melbourne. Intense market volatility over the last 18 months has driven demand for CFDs in Australia, with IG Markets' client numbers surging by 55 per cent in the 12 months to July, chief executive Tamas Szabo said. Its Australian base consists of about 30,000 to 40,000 clients, with between 20 to 30 percent of traders being active. The next biggest is considered to be CMC Markets which in the past dominated market share (CMC had a share of up to 60% in 2007 but this dropped to 32% in 2008 and now lags behind IG Markets at 20%, Investment Trends May 2010 CFD Report). Next follow Macquarie Prime, followed by First Prudential Markets, E*Trade, Commsec, City Index, and Tricom.

Mr. Tamas Szabo, CEO of IG, acknowledged that its range of trading and research tools, platform reliability and 24 hour service, along with a strong focus on transparency and client money protection, contributed to their number one ranking in Australia.

Szabo: 'In terms of client recruitment, I believe our stance on how we treat client funds has helped. When CFD trading with IG Markets, client funds, along with net running profits, are segregated into a regulated trust account at top tier Australian banks and are not used to meet our trading obligations or for IG Markets' own purposes, which is different to how other providers operate. The launch of spread cuts to 1 point on our Australia 200 index, and 1 pip on the popular AUD/USD currency pair also contributed to strong recruitment, with our internal figures showing the number of individual clients trading up over 30% year-on-year.'

According to the survey, almost half of active traders (47%) preferred the Direct Market Access (DMA) model when CFD trading, pointing out transparency and genuine market pricing as the main reasons for their choice. The main driver behind those that preferred the Market Maker model was ease of use. ASX CFDs still only accounts for 1% of the CFD market share, despite the Australian Stock Exchange being behind this new product.

Business at CMC Markets has also been substantial, with global revenue for the year to March up 64 per cent to £181 million, and Australian revenue up 51 per cent. The average number of contracts traded each month in the Asia Pacific was 540,000 and the notional amount traded per month was $33 billion.

Howkins says IG Group's strong growth is partly attributable to volatility in markets and partly to the yearning among investors for speculative investments. "Our clients like leverage because it allows them greater access to assets than they could get without leverage,'' he says.

IG Group reported a 50 per cent rise in revenue to £184 million for the year to May 2008. Growth in Australian revenue was 115 per cent. Retail customer numbers are now somewhere between 150,000 and 180,000 and notional turnover in CFD shares and indices is running at about $10 billion a month, according to industry sources. Traders calculated that the contracts for difference (CFD) market constituted up to 35% of ASX turnover in 2010, and the market is still expanding. Estimated annual turnover of $120 billion would make the retail CFD market bigger than the wholesale over-the-counter equity derivatives market. The Australian Stock Exchange also launched exchange-traded Contracts for Difference in 2007/2008, making it only the second exchange to have listed CFDs after London.

Different Markets have Different Trading Patterns

It is interesting to note that different countries have different characteristics - for instance an IG Markets spokesman has been recently quoted saying that the average holding period in Australian shares is approximately 3 days and if you compare that to the average holding period in Singapore this is more like 25 days. Business for IG in Singapore has also grown at a vastly disproportionate rate to the population - but this may be because Singapore very much has a speculative culture. In Germany where business is currently very good, the Germans are very less reactive to volatility compared with, say, in the United Kingdom. It is just a different type of risk appetite says Howkins, CEO of IG Index.

Volatility Woes

Despite the Australian Securities Exchange (ASX) recently launching a contracts for difference (CFD) service, a survey has shown that CFD traders are pulling back amidst the ongoing negative performance in the share market. The number of former or dormant CFD traders have also increased. According to Investment Trends' 2016 Contracts for Difference Report, the number of CFD traders in Australia decreased from 42,000 in 2014 to 37,000 in 2016.

Now this seems to fly in the face of the pundits who reckon that volatile markets are the best time to trade since large swings can be very profitable. In theory they're right. However, the problem lies in that those large swings are going in every direction except the predictable ones. So, if you think the markets are going to tumble and place an order to sell, they seem just as likely (and sometimes for no apparent reason) to go in the opposite direction. So although higher market volatility does mean more opportunities and encourage traders to trade more frequently; too much market volatility will have the opposite effect.

The annual survey also found that the average CFD trade size had fallen from $55,000 to $41,000, but of those people still trading, the frequency of their trades had increased.

There has only been a modest adoption of ASX's CFD service, representing just about 1 per cent of the total volume of CFD trades. The problem is of course the volatility and the CFD providers will try to attract dormant traders back into the market once the volatility has calmed down.

Volatility Effects

The persistent increase in volatility share prices has led to the number of active CFD traders in Australia falling from some 31,000 in April 2007 to 26,000 in August 2008, and average trade size fall from $55,000 to $41,000.

However, it appears that interest is shifting away from shares trading to index, currency and commodity trading. 'Eighteen months ago, CFDs on shares accounted for 80 per cent of our business. That's now about 15 per cent.' says Tamasz Szabo CFO of IG. In the initial years CFDs were considered by Australian traders as a great means of getting lots of gearing and benefiting from the market's rise but now a change in conditions is increasingly making people use CFDs as a tool to manage risk.

IG's biggest market is now currency CFDs which account to around 35% of their business. Index CFDs represent 25% of the business taken and commodity CFDs have almost overtaken equities. Most investors tend to prefer to trade in indices over individual stocks, particularly in the prevailing environment when stock markets are in free fall, although it can also be argued that it is quite difficult to pick movements in the indices at present as well.

Stock Market and CFD Trading in Australia

According to market research specialist Investment Trends, a growing distrust towards funds management schemes in the fallout of the global financial recession in 2008 has contributed towards an 8.3% increase in the number of online share traders to a record 650,000. Brokerage divisions of the big four banks hold a 84% share of the online trading market. CommSec is still the largest online share broker, and has increased its market share by 2% to 51% by May 2010 based on the number of stock market traders nominating the firm as their main broker. ANZ Banking Group's ETRADE had 17%, followed by Westpac Online with 10% and National Australia Bank's Online Trading with six per cent. Low brokerage costs and ease of using the trading platform were the most important factors in traders' decisions on selecting a broker.

At the present time contracts for differences are probably the most common financial product for private traders in Australia, although unconfirmed it is thought that CFD volumes account for approximately up to 35% of ASX exchange turnover. Given that CFDs are mainly an over-the-counter product exact figures are hard to come by.

CFDs

It's no secret that Contracts for Difference (CFDs) are extremely popular in Australia, which already claims the largest per capita share ownership in the world. It's thought that perhaps one third of the trading on the Australian Securities Exchange (ASX) originates with CFDs.

It wasn't always this way. It wasn't until 2001 that CFDs became accepted by traders, and two big brokerages (CMC markets and IG markets) who are based out of the UK opened in the following year. All this resulted in a peak of CFD trading activity in 2007. More recently CFDs have earned an undeserved negative reputation because of the market volatility that caught out many over exposed traders. This coupled with the recent failures of CFD brokerage providers Sonray Capital Markets and MF Global has led to increased scrutiny from the Australian financial Services Regulator ASIC in respect to how CFD providers deal with client monies.

Coincidentally, in 2007 the Australian Securities Exchange introduced exchange traded CFDs. Up until this time, and continuing, CFDs had been quoted only with the market maker model or direct market access (DMA). Although exchange trading offers greater transparency, it hasn't met with universal acceptance.

The problem with exchange traded CFDs is twofold. Firstly, traders are not able to get the range of products that they are used to from the market maker brokers. CFDs are renowned for being available on virtually every financial security you can think of, but there is only a limited range available on the exchange. You cannot even get exchange traded CFDs on all of the Australian shares, and there are no foreign share CFDs offered. There are limited currency and market index CFDs included on the exchange.

On the CFD market outside of the exchange you can enjoy CFDs on all major international markets, all indices, currencies, and commodities. There's virtually no limitation on what market is available to trade outside of the exchange CFDs.

The second problem is that exchange traded CFDs are, of necessity, more expensive to trade than those from market makers or direct market access. Obviously, there are other parties such as the clearinghouse and exchange who need to charge for their services, and these costs are on top of the brokerage fees. With the strict regulation and compliance needed, you will also find that the brokers are charging more for each transaction. This means that many Australian traders still stick with their over-the-counter CFD brokers.

Against this, exchange trading does offer some advantages. As mentioned above, there is greater transparency and conformity, and you're not subject to the whims of a market maker. The larger market making brokers tend to be better in this respect, but there is always the suggestion that the prices are manipulated unfairly. With exchange traded CFDs, you can be assured that there is a standard contract which again guarantees performance.

The other factor sometimes cited which again is not such a big issue with the selection of larger brokers in Australia is the counterparty risk. If your market making broker should happen to overstretch himself, and take on liabilities that he could not meet, then you have would have to take legal action to try and protect your interests. If you are trading exchange traded CFDs then the Australian Securities Exchange stands behind the transaction, with a specially set up clearing house to protect your funds.