CFDs: Coming up in the world

Opening a new market on the Australian Securities Exchange happens barely once every 15 years. After the futures market opened in 1960, the options market opened in 1975, and then the warrants market emerged in 1991. Today the ASX launches a contracts for difference (CFD) market, a project four years in the making that has led to Australia having the only exchange-traded market for CFDs in the world.

Australian investors have been ploughing into CFDs in recent years, and in the past few months even do-it-yourself super funds have been able to include CFDs in their portfolios. (Tax Office surprises on CFDs.- (Click Here). Still, many brokers have been reluctant to trade them, as the highly leveraged product was deemed too risky and having insufficient regulation. Today's market launch will change all that.

A CFD is an agreement between a buyer and a seller to exchange the difference in the value of an underlying instrument from the time the contract is opened to when it is closed. The instrument can be a share, index, futures exchange rate or commodity. The difference is determined by the period over which the contract is held.

CFDs are leveraged instruments, with the investor only paying a fraction of what the underlying instrument is worth, while being fully exposed to its price movements.

The upside is therefore very attractive, as the investor makes the full gain of the underlying security with a smaller initial outlay than a direct investment. However, the downside is similarly magnified – this is the essential risk. (To read more on how CFDs started in Australia - (Click Here).

New Entrants

While many brokers have avoided trading CFDs in the past, leaving the market open to new players such as CMC, IG Marks and Sonray, the ASX listing has drawn new entrants to the sector. The ASX market promises better regulations and increased transparency around broker operations. It also makes the market more accessible to investors. From today the ASX will offer CFDs over the 16 largest stocks on the market, with plans to broaden the list in the coming weeks.

The inherent risk of CFDs as a product is not in itself diminished with the ASX listing, but the market in which they move is more open. In other words, it’s the same vehicle but the road is clearer – what’s more, it should all become cheaper.

CommSec, one of 10 brokers registered to trade on the new ASX market, only started trading CFDs in November last year in anticipation of the ASX initiative and in response to client demand.

CommSec’s head of geared investments, Brian Phelps, says CommSec had avoided CFDs to protect its clients initially, but it became clear the investment tool was growing in popularity.

He says the “market model” or over-the-counter (OTC) model for buying and selling CFDs had worked against investors as they ended up with whatever price the market maker (or supplier) set. In other words, investors were “trading blind”.

According to Phelps: “We had some issues. The CFD market maker is basing the trade against the client, so effectively they’re trading against the client. The client ends up with whatever price the market maker strikes against the client, whereas we preferred to have an arrangement where the client could see the price and there was transparency for the client.”

The Commonwealth Bank-owned broker, with more than 1 million clients, now has over 1000 clients using CFDs via a direct-access model that allows the client to see the trade and the price. CommSec has also built in a number of protections to help manage the risk.

It has placed triggers in its systems to issue a margin call to the client if a stock price falls (or rises, for a short position) beyond a certain limit. Phelps says CommSec educates its clients to understand the risks and that immediate action is required if there is a margin call. Phelps adds that the broker has new 'liquidation triggers’ for extreme volatility, which automatically kick in when prices drop or increase in a dramatic fashion.

Another broker, Morrison Securities, has begun trading CFDs for the first time, comforted in having the ASX managing the market.

Morrison stockbroker Sid Khepatral says the ASX is not likely to compromise on any form of risk management, and so the market will probably be better managed than OTC CFDs. The ASX is also only charging flat margins per stock, as opposed to the OTC model of the seller charging a percentage of the stock – sometimes up to 5 per cent – which moves each day.

Morrison is offering the first two weeks of trading from the launch date as commission free to encourage interested investors to “have a go” and thereby shore up liquidity in the market.

"It’s a new product and requires participation to take off,” says Khepatral . “It’s like a cycle; once people start trading the liquidity is created and more and more people will find it feasible to trade.”

Other brokers registered with the ASX to trade CFDs are Bell Potter Securities, MF Global Australia, OMF Financial, Halifax Investment Services, ABN AMRO Morgans, Sentinel CFD, First Prudential Markets and Trader Dealer.

Trading boon

The new market should prove to be a boon for both the ASX and brokers. A survey conducted last year of more than 1000 traders by Brisbane-based Market Analysts Software found CFDs were now the second-most popular trading product in Australia, only five years after they were launched.

Of the traders surveyed, almost one in two – around 47 per cent – traded CFDs. Compared with other securities, 86 per cent of respondents traded directly in shares, 20 per cent traded futures and commodities, and 13 per cent traded options.

The age bracket with the highest percentage of CFD users was 30 to 49, where 54 per cent of respondents traded CFDs.

Market analysts will be conducting another survey this month to track the use of this product.