ASIC to crack down on contracts for difference as new internal report shows trades risker than investors believe

The Australian Securities and Investments Commission will crack down on the use of contracts for difference, with specific action to be taken against firms offering these types of trading instruments to unskilled investors, a new report reveals.

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.

The new ASIC report, based on interviews with a number of investors and internal investigations, reveals CFDs are actually more risky and complex than firms might disclose.

As a result, ASIC is preparing a new regulatory handbook and investor guide that will see CFD traders disclosure their cash balances and overall financial positions in order to promote CFD transparency.

Contracts for difference are a type of trading instrument used by investors to place bets on various outcomes, whether they be the performance of a particular sharemarket, or individual pieces of stock. But ASIC says a number of investment groups are portraying CFDs as “easy” trades, rather than disclosing their complexity and risk.

“[Groups] are targeting the mass market and this is a product which is not suitable for the mass market. It is a product which is extremely complex and extremely dangerous,” the report states.

“The majority of investors do not seek or receive personal financial advice prior to investing in OTC CFDs. Investors are attracted to CFDs because of the leveraged opportunities they offer, the low initial capital required to commence trading and the perceived ease of trading.”

While CFDs are freely traded in Australia, they are banned in several other nations and are under intensive scrutiny because of their inherent risk.

The report states investors are often confused about CFDs, do not receive sufficient information before trading them and “have difficulty understanding the information they do receive due to bias, poor presentation and subject complexity”.

As a result, ASIC will crackdown on risk disclosure and target misleading advertising which portrays CFDs as just another trading instrument, similar to individual stocks. It will also requests suitability tests for traders, and if the industry doesn’t shape up it will chase more comprehensive regulatory reform.

“We will continue to actively monitor CFD issuers’ advertisements, disclosure documents, seminars and conduct, and the volume and nature of complaints made to ASIC regarding CFDs. In particular we will continue to check that the key features, risks and benefits of CFDs are accurately represented to investors by issuers.”

“Given the complexity of CFDs, CFD issuers should take into account their target audience when advertising and promoting seminars”.

ASIC commissioner Greg Medcraft told the Australian Financial Review the corporate watchdog will be clamping down on CFD related activity, following growth in advertising campaigns promoting the trading instrument to new investors.

“People just don’t understand how dangerous these are. There is a real lack of understanding about the impact of leveraging and how it can devastate them,” he said.

“It’s actually riskier than going to the bookies because at least if you go to the bookies, if you put down $10,000 you only lose $10,000. Here, put down $10,000 and you’ve lost your house and your whole life savings”.

ASIC says CFDs are particularly risky because of a number of misconceptions. While some investors regard CFDs as easy to trade and generate relatively high returns, ASIC found these contracts need to be monitored frequently and that several investors only record minimal profits.

“Many traders reported 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.”

The report points out that when the market moves against a trader, they can lose much more than their initial investment because CFD investors are not automatically sold out of their investment positions.

According to the report, CMC Markets and IG Markets control about 70% of the CFD market in Australia. However, most providers are non-bank financial institutions are not regulated by APRA – about 26 out of 30 of the investors interviewed in the report claimed CFDs were under the regulatory jurisdiction of the ASX.

This misunderstanding is at the centre of CFD risk, Medcraft says.

“There is a lack of understanding about what people are actually investing in because some people think they own the underlying stock” he said. “We had recent examples in Sonray where people said “we were not getting the company dividends”.

Additionally, it also notes that the nature of trading CFDs is different to shares in that constant attention is required, and that a number of traders who attended education seminars on the subject still needed a large amount of education before they felt qualified enough to trade.

The report states traders should “take into account their target audience when advertising”, and not represent CFDs as “easy” when they are, in fact, extremely complex.

ASIC has previously said that it is discussing CFD trading with a number of firms, and is attempting to highlight how dangerous these misconceptions can be.

“We are having a dialogue with the CFD providers where they effectively provided derivatives on a listed security to see whether there is insider trading happening on the CFD market,” deputy commissioner Belinda Gibson told a Parliamentary Committee last month.

“The focus on derivatives more broadly then goes to some of our retail issues and our investor protection issues, that comes to looking at the quality of disclosure.”

Commissioner Tony D’Aloisio told the same committee that it hopes to broadcast some “very basic massages” to the public regarding CFDs. “I think we could get across basic messages: if you don’t understand it, don’t buy it. And the importance of understanding what you are investing in.”

The report comes as ASIC said last week it is holding the passport of former Sonray chief executive Scott Murray. Company director Russell Johnson has also given his passport to ASIC, and has provided an undertaking he will notify ASIC of any international travel.

The collapse of Sonray, which had over 4,000 accounts and $47 million in investors’ funds, has highlighted the danger of CFD trading. Early reports emerged regarding a rogue trader being responsible for the company’s losses, but administrators Ferrier Hodgson have said these allegations are false.