ASIC flags $40 million in refunds after review of risky financial products

Australia’s corporate regulator has secured a A$40 million refund to more than 38,000 investors in high-risk financial products following an industry review.

The Australian Securities and Investments Commission (ASIC) raised concerns that the marketing of high-risk products, known as ‘contracts for difference’ or CFDs, failed to clearly explain the risks.

This is just the latest intervention from ASIC in more than 15 years of ongoing concerns about the potential harm of CFDs to retail investors.

Tailoring the marketing of these complex financial products to an appropriate audience remains an unfinished task for the regulator.

What are CFDs?

In its report, ASIC says thousands of Australians lose money every year by trading CFDs. In 2023-2034, more than 133,000 people, or 68% of residential customers, lost more than $458 million.

Contracts for Difference are a type of financial instrument known as derivatives because they track the price of an underlying asset, such as shares, the Australian dollar and other financial products.

They are traded ‘over-the-counter’ (i.e. not on a public exchange) on platforms operated by CFD providers.

Investors can benefit from both upward and downward movements in financial assets with CFDs. Unlike buying shares, investors only have to pay a fraction of the price (the margin) upfront to enter into a CFD to track a financial product, in the hope of making a profit.

CFDs are leveraged products, meaning an investor borrows money to speculate on the price of an asset. A small price change in the underlying stock or commodity can have an amplified effect by increasing the profit – or loss – on the CFD.

For example, this could be as little as paying $1 up front to get the same trading power as $100.

Suppose you buy a CFD on one Apple share. Because you only have to pay one-fifth of Apple shares for the CFD, you can buy five Apple CFDs for the price of one Apple share. So if Apple’s price increases by $1, you could make $5. But if the price falls by €1, you can lose €5.

CFDs are therefore popular with investors because they can trade many financial instruments (betting on increases or decreases) and increase their trading power.

The downside is that trading on margin also magnifies losses if the market goes against the bet that a price will rise or fall. This has led to financial problems and cases of attempted self-harm.

ASIC is particularly concerned about issuers offering “margin discounts” to customers on certain transactions, to reduce the amount or “margin” the investor pays up front.

This is contrary to ASIC’s 2021 Product Intervention Order. ASIC published a further warning to CFD issuers in 2024 to stop this practice.

The complexity and risk of CFDs have led to them being effectively banned in the United States. In Singapore, prospective traders must pass a customer knowledge test before being allowed to trade CFDs.

To whom are the products marketed?

CFDs are not for the faint of heart and are only suitable for investors who are very knowledgeable and have a high risk appetite. Nevertheless, retail investors (ordinary people) are the dominant market that CFD issuers target in their marketing and advertising.

In ASIC’s recent report, the regulator found that CFD issuer websites were misleading consumers.

Some examples included promoting the underlying instruments, such as shares or commodities, rather than actual CFDs, and exaggerating the benefits of trading CFDs and underestimating the risks.

ASIC has forced 46 issuers to rewrite their websites, including removing misleading content and making them clearly state that they offer CFDs. One publisher updated 1,000 web pages.

ASIC chairman Joe Longo last week floated the idea of ​​banning the advertising of risky financial products, including CFDs.

The underlying concern is that inexperienced investors are attracted to complex financial products that carry a high risk of financial loss.

ASIC’s report shows that only 32% of retail clients made money from CFDs, after fees. Of those who traded the most per month (more than 50 trades), only 19% were profitable after fees.

There are fears that vulnerable investors are still slipping through the cracks

The main difference is between retail and wholesale customers.

Wholesale clients are generally institutions or sophisticated investors, highly experienced and more likely to trade complex derivatives and make profits. Wholesale customers are defined in law based on certain tests.

Wholesale customers also lose some of the consumer protections that apply to retail investors, such as receiving product disclosures and having access to dispute resolution.

Yet ASIC found that even wholesale customers lost money, with only 30% making a profit.

This raises concerns with ASIC about whether some retail customers have been wrongly classified as wholesale customers by the CFD issuers.

So it’s not the laws that need to be changed that clearly define sophisticated investors. What is needed is more research into how issuers misclassify potentially vulnerable investors.

The statistics are worrying because it means that the vast majority of investors lose money when trading CFDs, largely due to paying fees. On the other hand, this means that CFD issuers benefit from some of these losses while earning the fees.

This raises the question of whether CFD issuers are attracting suitable customers through advertising, as the losses for investors appear excessive. This suggests that advertising should carry warning labels, similar to advertising for other risky activities, such as sports betting.

Walking a fine line

CFDs have been around for over twenty years, with a market mainly made up of retail investors.

ASIC has managed to strike the fine balance between allowing their access, while regulating issuers’ marketing and activities without banning them outright. Potential investors would be wise to do their own homework and carefully assess the costs and risks of CFDs before entering the market.