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Australia, CFD providers ‘need to do more’: ASIC

The Australian Securities and Investments Commission (ASIC) has warned that that the derivative product contracts for difference (CFD) will face tougher regulations unless they voluntarily introduce firmer measures to protect retail investors.

Australian CFDs issuers needed to be more proactive in insuring investors understood their ‘complex’ trading practices, a recent ASIC study has revealed. ASIC has increased its scrutiny on the over-the-counter derivatives (OTC derivatives) market, such as CFDs, with the release of a guide on client monies. This guide aims to promote better disclosure and help retail investors properly understand the handling of ‘client money’ and associated counterparty risks.

ASIC’s ‘Report 205: Contracts for Difference and Retail Investors’ has shown that retail investors:

  1. are confused about how CFDs work
  2. do not understand the significant risks in trading CFDs
  3. do not seek financial advice before investing
  4. do not receive sufficient information to make informed decisions about trading CFDs

‘CFDs are a highly leveraged derivative product marketed to and traded by retail investors,’ ASIC said. ‘CFDs are essentially a leveraged bet on future changes in the market price of a share or commodity, or the value of an index or a currency exchange rate.’ ASIC commissioner, Greg Medcraft, stated: ‘Our healthcheck study shows CFD issuers need to lift their game in making sure investors understand how CFDs work and are aware of the very significant risks when trading these complex financial products.’

According to ASIC’s report, Contracts for Difference and Retail Investors, many retail investors did not seek financial advice prior to investing in over-the-counter CFDs, often did not receive sufficient information to make an informed decision about whether to trade, were confused about how the product operated and were careless to the risks of CFDs and as to how dangerous excess leverage can be.

It is also thought that about 15 per cent of traders had between 50 and 100 per cent of their investment portfolios in CFDs, with some using their retirement savings as trading capital. ‘These behaviours are all a cause for concern as the highly geared nature of the product means that small market movements could easily result in margin calls which traders may be unable to meet,’ the report says. ‘Many retail investors appear to be over-confident in their understanding of CFDs and their ability to successfully trade them.’

ASIC believes that the complex structure of CFDs means they are unlikely to meet the investment needs and objectives, or the risk profile, of many retail investors. ‘Many traders found that, overall, they just break even or are just slightly profitable over time. While many saw large returns on individual trades, these were counterbalanced by losses on others.’

ASIC also intends to release benchmarks for CFD product disclosure statements aimed at eliminating gaps in the information provided on CFDs. “Adoption of the benchmarks will improve the usefulness and effectiveness of CFD product disclosure statements, enable investors to better compare the products offered by different issuers and contribute to an improved investor understanding of key aspects of how CFDs operate, and the risks and benefits involved,” ASIC said in its report.

‘Investors considering trading in OTC derivatives, like CFDs, also need to be aware of counterparty risk. Counterparty risk arises if a CFD issuer collapses and has used your deposited money’. A shortfall could arise if the issuer used the money for trading for another client but could not obtain that money from the other client or cover it themselves. The warning comes as the corporate regulator confirmed last week it is holding onto the passport of Sonray Capital’s former chief executive Scott Murray. The company, which specialised in CFD trading, collapsed with accounts of over $40 million.

ASIC has proposed a number of recommendations, which in the majority of cases require a degree of self-regulation by the industry. Concurrently with REP 205, ASIC is also releasing Regulatory Guide 212, ‘Client money relating to dealing in OTC derivatives (RG 212)’ This guide provides issuers with clear guidance on ASIC’s expectations on what they need to do to comply with the client monies provisions of the Corporations Act, and what information they need to disclose to investors. These include new disclosure benchmarks for OTC CFD providers plus a request that all CFD providers to devise a policy on client suitability. The regulator also recommended a crack down on inappropriate advertising by the industry, while it plans to release a guide to investing in CFDs. The watchdog further warned that it will lobby the federal government to introduce possible law reform if improvements are not made.

ASIC’s recommendations for future action in the CFD market include -:

  1. disclosure benchmarks for OTC CFDS on an “if not, why not” basis;
  2. continued monitoring of CFD advertising; and
  3. publication of an investor guide to help retail investor understanding.

IG Markets and CMC Markets, which control about 70 per cent of the local market, have both welcomed the report. While a spokesman for IG Markets said the group was still assessing the report, CMC’s Australian managing director Barry Odes said a well-regulated industry was in everyone’s best interests.

CFD issuers have in the past dismissed ASIC’s concerns with the products, stating that clients are always assessed before they enter into CFDs, and their risks are always highlighted. While the exact size of the contracts for difference in Australia is not known, it is estimated that about 35,000 traders hold more than $350 million in the products.

Comments: Maybe if they regulated the CFDs market in Australia like they do in the UK with the FSA there wouldn’t be so many problems… Taking Sonray’s web site for instance which still proclaims: ‘Sonray Capital Markets founded in 2003 is a [sic] Australian financial services company (regulated by ASIC) providing access to global markets for Retail and Institutional clients around the world.’ Well, Sonray says it’s regulated by ASIC, so it must be safe to use then. Not.

The real failure here is that ASIC has witnessed what has happened in the industry over the past few years but has done nothing to improve the industry or protect consumers. The recent media announcements from ASIC have focused on the risks of CFDs but they seem to be missing the main problem. The CFD providers should be forced to protect client funds. CFDs aren’t evil, they’re just another trading tool. They won’t burn your life savings at the push of a button unless you are ignorant to their risks and good risk management in general. In fact, CFDs are fine if you know what you’re doing but just as you should make your own checks on the instrument you are thinking of trading so to should you check the provider you are investing your money with. It’s simple stuff yet all we want to do is blame someone else after the fact. Unfortunately, the plethora of ‘make money fast using CFDs’ type seminars suggests that losses are not uppermost in the minds of those anxious to make money without actually working.

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