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Published 20 June 2012 21:58, Updated 21 June 2012 07:28
Among the panoply of financial products available to Australian retail investors, contracts for difference (CFDs) undoubtedly sit at the riskier end of the spectrum.
Yet the inherent dangers of these products, which essentially enable investors to take leveraged bets on the direction of financial markets and instruments, haven’t deterred many thousands of Australians from regularly trading in them.
A report published by research house Investment Trends estimates that almost 40,000 Australians were classed as active CFD traders in 2010.
The figure, quoted by the Australian Securities and Investments Commission in its 2010 Regulatory Impact Statement 227 – known by the shorthand RG227 – indicates a remarkable uptake in CFDs since the product first hit Australian shelves in the mid 2000s.
“While this represents a smaller share of the market for financial investments than another popular leveraged investment, margin loans, we believe that more Australians invest in CFDs than many other major OTC [over the counter] derivative products,” RG227 states. “The CFD market has seen growth of over 300 per cent in the five years to 2010, and it is reasonable to infer that this growth will continue.”
Over the past couple of years, however, growth in the CFD market has approached stall speed, with both the amount invested and number of clients hardly budging.
As at 2010, ASIC estimated clients had about $350 million at stake in CFDs, while latest figures put the market size between $300 million and $400 million. CFD active client numbers have edged up from 39,000 in 2010 to 41,000 in 2011, the latest Investment Trends study shows.
The stagnant numbers, however, are masking an enormous amount of underlying client activity.
“While 10,000 new clients began trading CFDs over the year and 8000 dormant clients returned to CFDs, another 16,000 active [users] ceased trading in the 12 months to May 2011 – 60 per cent more than in the previous year,” the 2011 Investment Trends CFD report says.
The fall in growth could partly be explained by ongoing market volatility. There is a historical precedent – CFD trader numbers declined over 2007-08 (see table) as the global financial crisis boiled to the surface.
But the CFD industry has also seen its reputation take a dive over the last few years, blighted by dubious marketing practices and a slew of complaints.
Indeed, it was against this backdrop that ASIC launched its investigation of the sector, culminating in the publication of RG227 and the regulator’s 55-page masterpiece Thinking of Trading Contracts for Difference? (a must-read for any CFD trader).
The collapse of transnational securities trading firm MF Global last October dealt another serious blow to Australia’s CFD business. The failure left about $300 million of MF Global Australian client money in limbo, including some assets of CFD traders who, perhaps unknowingly, had their funds at risk in a co-mingled company pool.
(Although, as industry advocates point out, MF Global’s fall was unrelated to the CFD products per se, but rather investments in European debt of the wider firm.)
MF Global highlighted important distinctions in how CFD firms operate, as well as prompting Treasury to propose new rules on the use of client money. While ASIC had already set voluntary benchmarks for the CFD industry, a more prescriptive approach appears to be inevitable.
The industry, too, is fighting to clear its name. A group of providers recently created the Australian CFD Forum, which formerly met as a sub-committee of the Australian Financial Markets Association, to establish tougher industry standards.
While the six founding members – CMC Markets, GFT, IG Markets, City Index, Capital CFDs and Saxo – don’t speak for the whole industry (which with 44 providers, according to ASIC, is surprisingly numerous), the group represents between 60 and 80 per cent of providers.
Andrew Merry, head of Capital CFDs, says the Forum plans to produce its own benchmarks that exceed current ASIC guidelines, while also pushing for tougher legislation.
As well as the two MF Global-inspired points – use of client money and provider financial strength – Merry says the Forum is also keen to establish strong client education standards.
“There’s nothing wrong with the product,” he says, “but many people don’t understand leverage. There’s a massive opportunity [with CFDs] but we have to make sure the clients understand leverage.”
Louis Cooper, head of fellow Forum member CMC Markets, agrees the industry has to try harder to educate clients about the risks of CFDs and exclude those unqualified to trade.
Cooper says CMC Markets, for example, rejects about 10 to 15 per cent of client applications, shunting them off to further education.
The Forum, he says, should help repair the industry’s reputation.
“We can have a shared voice, and develop benchmarks we can be proud of,” Cooper says.
Merry is likewise hopeful the Forum can create a more positive profile for the CFD industry.
“If people feel the corporate governance of CFD providers has improved, they will feel more confident about the products,” Merry says.
He does, however, admit CFDs must be treated with respect. Investment Trends research cited in ASIC’s RG227 states that CFD users reported about 40 per cent of trades as winners, 44 per cent as losers and 16 per cent as break even over the 12 months to May 2010.
ASIC, however, suspects the actual losses were higher as “participants often tend to under-represent investment losses due to embarrassment”.
“These data also relate to current traders only – had they included those who have ceased trading, reported losses may have been higher,” RG227 states.
Merry says the CFD loser/winner ratio may be as high as 70/30 but he puts that down to uneducated and inexperienced investors taking ill-judged risks, especially first-year traders.
“It’s the same as learning any other skill set,” he says.
“For example, if you’ve just learnt to ride a motorbike, it’s best to go slow or you could smash into a wall.”