Last year ASIC conducted a review of the retail OTC derivatives sector (forex brokers) finding that up to 72% of traders lost money when trading CFDs. Alarmingly, there were also several incidents of misconduct. This led to five key changes for ASIC regulated forex brokers that will begin to be enforced this month (29 August 2021).
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Contract for Difference (CFD) trading involves speculating on future price movements of one underlying asset vs another asset that is often currency. When trading CFDs, you do not own or have any interest in the underlying asset. For instance, when trading the Australian Dollar versus the Euro, you are not buying or selling the physical currency. Instead, you are predicting whether the forex pair will increase or decrease in value, with gains and losses multiplied through leverage. Unlike CFDs, share trading involves buying and selling the physical underlying asset (being the stock) and leverage is not available.
In 2019 ASIC found there were 1,000,000 active traders using Australian brokers that offer CFD and forex trading. Annual turnover was $22 trillion, with traders making 675 million transactions.
The retail CFD/forex trading market doubled in size between 2017 to 2019. Then COVID led to a spike in activity with August 2020 having 86% more searches compared to the previous year. In 2021, Australians interest in forex and CFD trading remains 50% higher than the previous year (just before COVID hit). There are 8,100 searches for forex trading and 6,600 searches for CFD trading as shown using Google Keyword Plan.
Justin Grossbard, Director of Compare Forex Brokers said that “while interest in CFD trading terms has risen steadily, there has been a breakout in new Millennial-focused CFD terms like ‘copy trading’ up by 436% over the past year.”
When trading forex and other CFDs, investors are exposing themselves to unpredictable markets and volatile assets. As an investment activity, CFD trading is considered very high-risk. This month, the country’s financial authority, the Australian Securities and Investments Commission (ASIC) is implementing tougher regulation to combat the high percentage of retail traders losing money.
An ASIC August 2018 report showed:
In May 2020, ASIC released a report explaining how the COVID-19 global pandemic has affected financial markets and retail trading.
From 24 August to 3 August 2020, ASIC found that Australian retail brokers were turning over twice as much as the six months prior. During the peak of the pandemic, retail brokers’ average daily turnover increased to $3.3 billion, from $1.6 billion.
Two factors contributing to the spike in trading activity include:
In the report, ASIC highlighted how the COVID-19 induced volatility has magnified the high risk of losing money when trading with high leverage. From 16 to 22 August 2020, retail CFD and forex traders lost a staggering $428 million gross.
The financial authority found that the increased volatility was resulting in a higher incidence of slippage and gapping events, causing a number of traders to end up with negative trading account balances. In the same week of August 2020, 5,488 Australian retail traders went into a negative balance, amounting to -$4 million.
Due to the unprecedented nature of COVID-19 and the volatility and uncertainty it is causing, many forex brokers forgave a portion or all of the negative balances owed to them.
Lastly, the report found that many trading balances were being eroded by costly overnight funding costs (swap rates). For example, oil CFDs swap rates had increased to up to 220% pa.
Amid the extreme volatility from 16 August to 19 August 2020, ASIC determined that between 56.9% and 63.2% of retail traders were losing money. Over the five-week period, retail traders signed up to Australian brokers lost a total of $774 million.
Australian traders are not the only country that sees such high rates of retail traders losing money. Similarly to Australia, between 62% and 77% of retail investors in the United Kingdom lose money when trading CFDs with UK Brokers.
Below outline the changes to CFD and forex trading regulation and the impact on the industry. The changes come into effect on the 29 August 2021.
The Australian Securities and Investments Commission (ASIC) announced on the 23 October 2020 that they are introducing 3 major changes to Australia’s CFD and forex trading rules. Going forwards, ASIC regulated brokers are required to enforce stricter rules for retail traders, including:
ASIC believes the leverage previously available for retail CFD and forex trading was too high, resulting in individuals being exposed to unsuitably high risk. ASIC decided on a huge reduction in the maximum leverage that brokers can offer retail traders, down to 30:1 from 500:1.
South Africa (FSCA) is the only well known regulated market where brokers offer higher leverage than Australia (ASIC).
ASIC has placed leverage caps of 30:1 for major currency pairs and 20:1 for exotic and minor currency pairs. This is a 94% reduction from the previous levels offered by Australian forex brokers such as Pepperstone.
Other leverage restrictions include:
ASIC definition of a major currency pair includes any fx pair that comprises any two of the following currencies: AUD, GBP, CAD, EUR, JPY, CHF and USD.
Major stock exchanges include S&P 500, S&P/ASX200, NASDAQ 100, NASDAQ Composite, Nikkei Stock Average, Dow Jones Industrial Average, DAX, CAC 40, FTSE 100 and EURO STOXX 50.
Reducing leverage will reduce the risks associated with trading, making it harder to make large profits and losses. This will help protect traders, but some individuals who require high leverage (such as automation traders) may choose brokers regulated overseas, or even unregulated brokers.
Offshore traders make up 80% of Australia’s trading volume in retail CFDs, and they are more likely to choose a broker that’s not regulated by ASIC. When the FCA introduced leverage caps to the UK (similar levels to the ASIC October announcement), local brokers saw a 6.7% decline in net income.
The leverage drops of over 90% will lead to:
ASIC has announced stricter trader protection regulations. At present, ASIC requires brokers to separate all clients’ funds from company funds in segregated bank accounts. This month brokers will be obligated to follow additional investor protection rules that are common in areas such as Europe.
Below compares the main forms of investor protection required by different financial authorities around the world.
On the 23rd of October, ASIC announced a standardised CFD margin close-out arrangement that requires brokers to close out all of a traders’ open positions, prior to them losing all their money. Additionally, all Australian brokers will need to protect their customers against negative account balances, know has negative balance protection (NBP).
Going forwards, Australian brokers will be required to provide three key investor protection policies to all retail traders:
Increasing regulation around investor protection moves the risk of trading from the retail investor to the broker. CFD and forex brokers will either need to wear the costs or increase their fees.
Doing the latter may be difficult because of the high levels of competition and the threat of pushing traders to overseas brokers who offer higher leverage.
Some brokers in Australia offer rewards for activities such as signing up to a broker, referring a friend, or trading high volumes.
ASIC is now prohibiting certain types of promotions or incentives. Brokers cannot induce customers to open or fund a trading account through rewards, as well as give or offer a gift, rebate or discount trading credit or balances.
Going words, ASIC will restrict brokers’ promotions to two forms:
The below table compares incentives offered by Australian brokers in August 2020.
An example of an incentive targeting prospective clients is City Index’s sign up bonus. The promotion does not explain that to receive the $1,000 bonus it requires new account holders to deposit a minimum of $7,500 along with placing 12 trades with the face value of either:
Free gifts, spread rebates, and bonus credits can attract vulnerable retail investors that do not fully comprehend the high-risk nature of CFD trading.
With nearly a third of Australian CFD traders earning less than $37,000 per year and a 40% increase in brokers marketing budgets between 2017 and 2018, ASIC believes that brokers are targeting inappropriate audiences that may not be aware of the high risk of losing money when trading CFDs.
ASIC has banned forex (CFD) brokers from giving any bonuses or inducements to retail traders. This includes offers such as free iPads to bonus credits, as was the case with City Index. This is in line with regulation across Europe.
ASIC believes that Australian brokers’ current marketing practices are aggressive and lack transparency. Research conducted by the financial authority found that advertising materials produced by certain brokers were misleading and failed to target a specific target market. Instead, adverts targeted a broad audience that doesn’t necessarily suit the product’s risk profile.
eToro is the best example of a broker advertising OTC derivatives trading as an accessible, low-risk hobby. The YouTube ad below shows Alec Baldwin using sock puppets to explain the ease of trading with eToro. You can see the YouTube video here.
Another example of eToro advertising is via social media platforms such as Facebook, where adverts target millennials and novice traders. The eToro sponsored post below (a screenshot from 07/02/2020) uses cryptocurrency as the gateway to derivatives OTC trading.
Download the full-size eToro Facebook ad.
The last example is a banner advertising on Money Magazine on 03/04/2020.
View the full banner advertisement on Money Magazine here.
Similar to gambling pre-legislation changes, targeted advertising can lead to unsuitable traders signing up with brokers who don’t understand the risks. In regions such as the EU, heavy restrictions are in place to eliminate predatory marketing tactics.
While ASIC banned joining bonuses, it made no announcement on advertising restrictions. This is a key difference between the new rules coming into force in Australia compared to the current standard in Europe.
ASIC considered increasing the risk warning requirements on all information provided by Australian brokers to retail investors. Yet, the regulator stated in its recent report that they found little evidence that risk warnings are effective, and are not introducing further warning and disclosure requirements.
Initially, ASIC proposed increased transparency surrounding charges such as overnight financing fees and commission costs.
The UK has already implemented risk disclosure requirements for all FCA licensed brokers. Pepperstone displays risk disclosures on its United Kingdom site, but not the Australian website. You can see this disclosure outlined below.
View the high-resolution PNG homepages of Pepperstone:
ASIC is not increasing risk warning and disclosure requirements. This may be a requirement long-term but will not come into force this month.
The Managing Director of CompareForexBrokers.com (Justin Grossbard) predictions vs reality were:
CompareForexBrokers updated the contents in this article since ASIC confirmed on 23 October 2020 upcoming regulation changes that will affect CFD and forex trading in Australia. Certain information in this are forecasts and not facts.
Content, graphics and other material on this page can be republished but we request you reference this page in the material so users can see the full data behind it – https://www.compareforexbrokers.com/australian-forex-brokers/2021-asic-changes/.
The most frequently traded instruments are binary options, margin foreign exchange, and various Contracts for Difference (CFDs).
Large overseas financial hubs implemented heavy leverage caps to reduce traders’ exposure prior to 2015, including:
The biggest change occurred in 2018 when The European Securities and Markets Authority (ESMA) enforced leverage caps throughout the EU region to 30:1. In 2019, individual EU countries implemented their own version of these leverage cap guidelines. The most recent change has been in Singapore, where the Monetary Authority of Singapore (MAS) reduced maximum leverage from 500:1 to 200:1 in 2019.
Up until now, forex traders in Australia could access leverage up to 500:1 when trading under a retail investor account. When trading forex and CFDs with high leverage, both gains and losses are magnified. For example, if a trader deposits $10,000 and enters a trade with 500:1 leverage, the value of the position will equate to $5,000,000. Furthermore, trading costs also increase with leverage as they are calculated on the total value of an open position.
ASIC has confirmed that going forwards, retail traders will be offered maximum leverage of 30:1.
A capital requirement enforced by many financial authorities around the world (including ASIC) is separating client funds from company funds. Segregated accounts ensure traders’ account balances are not used as operational capital, as well as offering protection of trading balances (up to a specified amount) if a broker were to become insolvent.
Australian brokers are now required by law to close out one or more open positions if a client’s trading account balance falls below 50% of the total margin requirements of all open positions.
Financial authorities such as the ESMA, IIROC and FCA require brokers to provide retail clients with Negative Balance Protection (NBP) that limits retail investors’ losses. Following suit, ASIC will now require all Australian brokers to offer negative balance protection to retail clients.
In the past, certain Australian brokers offer NBP although not legally required. For instance, Pepperstone offered a form of negative balance protection through its automated stop-out policy. Designed to minimise losses, open positions were closed out when a trader’s equity decreased below 20%-50% of their margin requirements. Similarly, Plus500 AU ensured traders’ didn’t enter negative balances through its Margin Call feature. Unless a trader adds funds to their trading account, the broker will close positions when equity is less than maintenance margin requirements.
In 2018, the European Securities and Markets Authority (ESMA) began enforcing various measures to reduce the number of retail investors losing money when trading forex and CFDs.
Historically, European retail brokers could offer clients leverage up to 500:1. To reduce the risk retail investor traders were exposing themselves to, the ESMA now requires brokers to offer clients leverage that is no more than:
The ESMA also implemented margin close-out rules. The financial authority now requires brokers to automatically close-out open positions held by retail investors if their equity falls to less than 50% of their margin requirements.
In addition to reduced leverage and margin close-out levels, the ESMA introduced negative balance protection intending to minimise losses experienced by retail clients. This means that a trader cannot lose more than what they deposited, with no risk of a trading balance entering a negative balance.
The ESMA prohibits Euro Zone brokers from offering monetary and non-monetary benefits and bonuses. When promoting, selling or distributing CFD products, brokers’ cannot offer incentives for activities such as depositing a certain amount of funds or trading high volumes. The ESMA believes that such incentives influence retail traders to trade high-risk products that they otherwise may avoid.
The ESMA requires risk disclosures to be included on all information provided by the broker to retail investors. The standardised risk warning must state the percentage of retail clients that have lost money when trading CFDs with the specific broker, with disclaimers visible on all marketing and sales materials.
Due to the increased regulation and investor protections, CFD brokers likely experienced lower trading volumes from retail investors. In 2019, the FCA announced two UK brokers (that represent 43% of the UK’s CFD market) experienced a 6.7% reduction in net income after the ESMA introduced the new regulations in 2018.