Forex and CFD rules, a guide by DottoIn plain words

Guide 03 · The account

The protections on a retail CFD account

A retail CFD account carries two protections against runaway losses: margin close-out, which closes positions before losses pass prescribed levels, and negative balance protection, which means a retail client never loses more than the money in the account. ASIC’s Regulatory Guide 227 adds benchmarks on client money, opening deposits and the provider’s own finances, which an issuer addresses in its disclosure on an ‘if not, why not’ basis.

General information, not financial advice. The official place to check is Moneysmart’s page on CFDs; the benchmarks are in ASIC’s Regulatory Guide 227.

Each protection below is tagged by where it comes from: ASIC’s order for conditions set by ASIC’s product intervention order, RG 227 benchmark for what ASIC’s regulatory guide expects an issuer to disclose, and Corporations Act for a duty in the Act.

ASIC’s order

Margin close-out

Moneysmart lists margin close-out protection among the things CFD issuers must apply when selling to retail investors: one or more CFD positions have to be closed before losses exceed prescribed levels. The order carries a note on how that is done:

“The CFD issuer must do all things necessary to ensure that it acts efficiently, honestly and fairly in terminating open CFDs: paragraph 912A(1)(a) of the Act.”

ASIC’s CFD product intervention order, Note 1 on margin close-out protection

RG 227 adds a benchmark of its own. Whatever an issuer’s other margining practices, its policy should require it to take reasonable steps to tell investors before closing out their positions.

ASIC’s order

Negative balance protection

Moneysmart lists negative balance protection among the things CFD issuers must provide, so a retail client can never lose more than the amount of money in their CFD trading account. Moneysmart sets out why that matters: for retail clients, losses can quickly grow past the margin used to open a position, and ASIC’s product intervention measures are what limit them to the money held in the account.

The protection belongs to retail clients. Moneysmart warns that a wholesale client may not have it, or margin close-out protection, and can end up owing the CFD provider money; retail or wholesale: why it matters covers that line.

ASIC’s order

No gifts for trading

Moneysmart says CFD issuers must not offer incentives to trade CFDs, such as trading credits, rebates or ‘free’ gifts. When the order took effect, ASIC named inducements to become a client or to trade as one of the sales practices that magnify retail clients’ CFD losses.

RG 227 benchmark

The client money

RG 227, issued in August 2011, expects an issuer to keep, and follow, a clear policy on how it uses client money. The guide also points to the Corporations Act, which in sections 981A to 981H sets rules for how an AFS licensee must deal with money its clients pay it for a financial service or product.

Moneysmart says a CFD issuer operating in Australia needs an Australian financial services licence, and has to meet requirements on its financial resources, its risk management and how it handles client money; those requirements lower the risk but do not remove it.

RG 227 benchmark

The opening deposit

When an investor opens an account to trade CFDs, RG 227 says an issuer should generally accept only cash or cash equivalents as the opening collateral. If credit cards are used, the issuer should accept no more than $1000 by credit card to fund the account.

RG 227 benchmark

When the market behind it stops

If there is a trading halt over the underlying asset, or trading in it has otherwise been suspended under the rules of its market, RG 227 says the issuer should not let new CFD positions be opened.

RG 227 benchmark

If the provider fails

Moneysmart is plain about this one: a trader may still lose money if the issuer fails or becomes insolvent. RG 227 asks the PDS to explain that, if the issuer defaults, investors may become unsecured creditors in an administration or liquidation, with no recourse to any underlying assets.

To let investors judge the issuer itself, RG 227 says it should make its latest audited financial statements available to prospective investors free of charge, on its website or on request.

Corporations Act

When the terms change

RG 227 restates a duty from the Act: under section 1017B an issuer must tell investors of any material change to a matter, or a significant event affecting one, that would have had to be in a PDS. When the change is adverse, the guide says notice generally has to come as soon as practical, and within three months in any event; for an increase in fees and costs, product holders get at least 30 days’ notice before it happens.

How the RG 227 benchmarks work

ASIC describes RG 227 as written for anyone involved in issuing, selling or advertising over-the-counter CFDs, margin forex and similar products to retail investors. It sets out guidelines for better disclosure, to help retail investors understand and assess these products.

From 31 March 2012, ASIC expected every new PDS given to retail investors to address the benchmarks on an ‘if not, why not’ basis. ASIC says it will consider using its stop-order powers under section 1020E if it thinks there is material non-disclosure or misleading disclosure. The margins that go with these protections are in the leverage limits; the short version is on the home page.