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

Australia’s corporate regulator has secured refunds of A$40 million to more than 38,000 investors in risky financial products, following a review of the industry.

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

This is just ASIC’s latest intervention in more than 15 years of ongoing concern with the potential harm of CFDs to retail investors.

Fine-tuning the marketing of these complex financial products to a suitable audience remains an unfinished task for the regulator.

What are CFDs?

In its report, ASIC said thousands of Australians lose money trading CFDs every year. In 2023-34, over 133,000 people, or 68% of retail clients, lost more than $458 million.

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

They are traded “over-the-counter” (meaning not on a public exchange) on platforms run by CFD providers.

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

CFDs are leveraged products, which means an investor is borrowing 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 gain – or the loss – on the CFD.

For example, this can be as little as paying $1 upfront to gain the same trading power as $100.

Let’s say you buy a CFD on one Apple share. As you only need to pay a fifth of the Apple stock for the CFD, you can buy five Apple CFDs for the price of one Apple share. So if the price of Apple rises by $1, you could make $5. But if it falls by $1, you could lose $5 dollars.

CFDs are therefore popular with investors as they can trade many financial instruments (betting on rises or falls) and magnify their trading power.

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

ASIC has been particularly concerned about issuers offering “margin discounts” to clients on particular trades, to reduce the amount or “margin” that the investor pays up front.

This contravenes 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 has meant they are effectively banned in the United States. In Singapore, prospective traders need to pass a customer knowledge assessment before they are allowed to trade CFDs.

Who are the products being marketed to?

CFDs are not for the faint of heart and would only suit investors who are very knowledgeable and have a large appetite for risk. Despite this, retail investors (regular people) are the dominant market targeted by CFDs issuers in their marketing and advertising.

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

Some examples were promoting the underlying instruments, such as shares or commodities, rather than actual CFDs, and overstating the benefits of trading CFDs and understating the risks.

ASIC has forced 46 issuers to rewrite their websites by removing misleading content and making them clearly state that they are offering CFDs, among other changes. One issuer amended 1,000 web pages.

ASIC chair Joe Longo last week floated the idea of banning advertising for high-risk financial products, which would also include CFDs.

The underlying concern is that unsophisticated investors are being attracted to complex financial products that carry great risk of financial loss.

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

Fears vulnerable investors still slipping through the cracks

The key difference is between retail and wholesale clients.

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

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

Yet, ASIC found that even wholesale clients lost money, with only 30% making profits.

This raises concerns for ASIC of whether some retail clients were misclassified as wholesale clients by the CFD issuers.

So, it is not the laws that need changing, which clearly define sophisticated investors. What is needed is more scrutiny of how issuers misclassify potentially vulnerable investors.

The statistics are concerning as this means the large majority of investors are losing money trading CFDs, driven largely by paying fees. On the flip side, this means CFD issuers are profiting from some of these losses as they earn the fees.

This raises questions of whether CFD issuers are attracting suitable clientele through advertising, as the losses by investors seem 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 existed for over two decades, with a market that is predominantly comprised of retail investors.

ASIC has managed the fine balance of permitting their access, while regulating issuers on their marketing and operations without banning them outright. Potential investors would be wise to do their own homework to carefully assess the costs and risks of CFDs before wading into the market.