Traders continue to roll the dice
Blind bet … ill-informed CFD investors could find themselves out of pocket. Photo: John Woudstra
The Australian market in contracts for difference, or CFDs, continues to grow, despite official concerns that even experienced investors don't fully grasp the risks involved in using these instruments.
According to the latest Investment Trends Australia CFD Report, an estimated 44,000 Australians traded CFDs in the 12 months to May 30, up from 41,000 a year earlier. The 7 per cent increase was up from 5 per cent growth in the 12 months before. ''Against a backdrop of challenging economic conditions, the market has shown resilience,'' says Pawel Rokicki, a senior analyst at Investment Trends.
However, the Australian Securities and Investments Commission (ASIC) continues to pay close attention to CFD trading, a year after taking official steps to tighten the rules for providers of over-the-counter (OTC) CFDs.
Last year, the regulator found that most investors didn't understand how CFDs worked, with many believing they're buying the underlying security - a share or currency, say - when in fact they're buying a derivative instrument.
The CFDs allow investors to take a bet on changes in the prices of assets such as equities, share indices, commodities and foreign exchange, using borrowed money to multiply their exposure.
''[They] have been compared with gambling, but CFDs are far more risky than having a punt at the TAB,'' the chairman of ASIC, Greg Medcraft, wrote last year. ''Because CFDs are a full-recourse leveraged investment, you can end up owing much more than your initial investment or margin.''
ASIC research also found investors didn't receive enough information to make informed decisions.
The study showed that some CFD investors traded even though their circumstances suggested they shouldn't. ASIC estimated about 15 per cent of CFD traders had 50 per cent to 100 per cent of their portfolio in CFDs.
In response, ASIC is taking action in several areas: requiring better disclosure for retail investors; raising the bar on the financial strength of CFD issuers; and trying to keep a lid on advertising claims.
Since March, ASIC has required that CFD issuers meet new disclosure benchmarks. It says all issuers have complied. ''Later this year we'll conduct targeted, risk-based reviews of the quality of these disclosures,'' an ASIC spokeswoman says.
In addition, ASIC has issued a regulatory guide stepping up the financial requirements for issuers, saying the bar needs to be higher ''to ensure licensees have adequate financial resources to properly oversee and manage the operational risks inherent in the OTC derivatives market''.
Two CFD providers have collapsed in recent times. When it failed last year, the New York-based broking house MF Global was the third-largest player in the local CFD market. Sonray, one of the first brokers to advise on CFDs in Australia, was placed in liquidation in October 2010 and its chief executive jailed a year later after a $46 million shortfall was uncovered.
ASIC is also monitoring advertising of CFD products ''to ensure the marketing does not give a misleading impression of the risks or potential rewards of CFD trading,'' the spokeswoman says.
ASIC suggests you ask these questions before trading CFDs:
■ What is the financial position of the issuer?
■ What is the issuer's policy on the use of client money?
■ How does the issuer determine the prices of CFDs it offers?
■ Can the issuer change the price after you've placed your order?
■ When processing CFD trades, does the issuer enter into a corresponding position in the market for the underlying asset?
■ If there's little or no trading going on in the underlying market for an asset, can you still trade CFDs over that asset?