Exchange Traded CFDs

CFDs are usually one of two types, direct market access (DMA) or market made, but there is a third type. This third type is called the exchange traded CFD, and they are currently only available on the Australian Stock Exchange (ASX) for a limited number of financial securities. The ASX established them in 2007, but they appear to have been relatively slow to catch on albeit there has been speculation that other exchanges around the globe were seeking to implement a similar system. In fact the London Stock Exchange (LSE) was looking into implementing a similar scheme and abandoned it for an indefinite period of time in 2009. ASX exchange-traded CFDs are listed on the ASX. They are traded through brokers authorised by the ASX to deal in these CFDs. Note that the market for these CFDs is still separate to the market for the underlying assets.

 

Basically the goal is to create a regulated market for trading CFDs, where individual trades are monitored by an authorized government body. The ultimate purpose for this type of market is perfect transparency. The simple workings of exchange traded CFDs are that the broker or provider is required to hedge every CFD transaction by actually purchasing the shares on the market its self. This will give perfect synchronization between the CFD traders and the price movements of the underlying exchange. Essentially, Exchange Traded CFDs aim to include all the desirable components we associate with stock exchanges along with all the desirable components associated with trading CFDs.

In the exchange-traded model, you are trading CFDs that are listed on the ASX. In the exchange-traded model, you can't directly trade ASX exchange-traded CFDs yourself. This means you must open an account with a broker authorised to trade these CFDs. The advantages claimed for exchange traded CFDs are three-fold. There is the market independence of using the ASX, which means it does not matter which CFD broker you trade through. There is a standard contract and the presence of regulation ensures that all your dealings are fair and without any bias. In particular the contract for differences terms and conditions are standardised by the ASX, which reduces some of the risks.

  • Exchange traded CFDs are settled by a central clearing counterparty that acts as a guarantor between every buyer and seller.
  • The contracts are standardized.

In this model, there is a level of transparency. All orders are placed through an order book on the ASX, which gives everyone access to transaction reports of the CFDs bought and sold, bid and offer prices, volumes, and other information. All orders are executed under strict priority and people who trade CFDs may be price makers.

Finally, there is elimination of counterparty risk. While this may not be a significant risk if you choose to go with one of the major CFD providers, there is always the possibility, however remote, that funds can be misappropriated, or the provider can otherwise be unable to make payment. When you use exchange traded CFDs your trade is backed by the exchange irrespective of any provider mishap.

ASX 24 (formerly known as the Sydney Futures Exchange), which is part of the ASX Group, is in charge for registering, clearing and processing all trades in ASX exchange-traded contracts for differences. ASX 24 acts as a counterparty to these CFD transactions, which implies that both the buyer and the seller contract with ASX 24 and not directly with each other. This significantly reduces counterparty risks.

Certainly, there have been questions raised about OTC or market maker providers, and whether they may take advantage of their clients in the way that they set or change prices. Exchange traded CFDs eliminate this question, but have been shown to have other disadvantages.

ASX CFDs aren't that good (despite ASIC advocating the exchange products) not very liquid or useable. You can trade EVERYTHING on the other OTC providers (example carbon, rapeseed, Singapore futures, palladium, UK shares etc ad nauseam).

Disadvantages of Exchange Traded CFDs

The disadvantage that many seasoned CFD traders may face is that there is only a limited range of CFDs available on the exchange. Traders may find that the securities they normally deal in are simply not available. Secondly, it has been found that there are many costs associated with exchange traded CFDs which ultimately mean they are more expensive to trade than over-the-counter CFDs with a reputable CFD provider. Using exchange traded CFDs involves several parties, each of which need to be paid for their services, so inevitably the basic cost is higher.

CFD prices on the exchange are supposed to closely follow the market price of the underying asset. But because of the lack of take up in trading on the ASX exchange, CFDs market participants are experiencing a lack of liquidity. Liquidity is provided by the market makers of the ASX who ultimately have to make the trading work, however with the scarce liquidity it has been noticed that the prices of certain exchange traded CFDs are actually more likely to be out of line with the underlying financial instruments than over-the-counter CFDs. Interestingly, because the exchange model makes the market on the basis of CFD transactions and due to the low level of trading the spreads available on the exchange traded CFDs are reportedly about twice as large as on other types of CFD.

To conclude, ASX CFDs do have the inherent benefit of being cleared and traded on an exchange, however they have several drawbacks and most CFD traders prefer to take either the Market Made or Direct Markets Access route.

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