There's A Row Brewing In The Australian Market Over How To Save You From Other People's Bad Trades

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One of the great advances of technology has been the democratisation of access to markets that online trading platforms have offered retail traders.

But unlike banks, which need to hold large amounts of capital in order to do business, and stock brokers, who are held to a higher standard, ASIC currently mandates that an Australian Financial Services Licence (AFSL) holder who runs an online brokerage firm offer only needs $1 million in assets to open its doors.

In Australia it is estimated there are perhaps a little more than 41,000 traders active in the contract for difference (CFD) market with perhaps 50,000 or more trading through online Forex brokers.

But a large number of the firms who deal in this space, indeed the numerical majority, are non-traditional financial system players and brokers with little backing, save for a few exceptions, of a major financial institution.

They just need an AFSL with the appropriate allowances and $1 million in capital, and ASIC says they are good to go.

This is regardless of the fact that the clients of these brokers can have open positions in the tens of millions of dollars. Some of these brokers, particularly in the FX space, can transact many tens of billions of dollars in turnover per month.

It is a situation that seems at odds with the interests of clients and the protection of their money and the matter is currently under consideration by the federal government, through the office of Finance Minister Mathias Cormann.

Indeed after the collapse of what was previously the global powerhouse of retail trading, MF Global in the US during 2011, and the related collapse of the Australian operation, ASIC sought to examine the operation of brokers who operate in the retail online space.

It is an important issue because even though the liquidator of MF Global Australia, Chris Campbell of Deloitte has in many cases recovered more than 90 cents in the dollar, he told Business Insider that there were aspects of the law “which need to be cleaned up”.

These aspects Campbell is referring to are related to the use of client funds by the brokers, who owns those funds, and when title to the money is transferred.

Under ASIC’s RG 212 the use of client money by ASIC Licensees (holders of an AFSL) are restricted in how they handle client money held on deposit, where they place it and what they do it.

Given the potential mismatch between what a broker might hold in client funds as deposit or margin, and what its own capitalisation might be, it would be reasonable to assume that client money is segregated from the firms’ accounts and held in trust.

But as Deloitte’s Campbell told Business Insider, and crucially what the MF Global, Opes Prime and the more recent collapse of GTL TradeUp highlight, it is not as simple as an online brokers’ assertion that client funds are held in a separate account.

Here’s why.

Pooled risk

CFD’s and margin forex are leveraged “over the counter” derivatives. The use of leverage means that the client can trade a much large position than they have on deposit. I can put $1,000 in my account and trade a position of $1000 or I could trade a position of $100,000 – 100:1 – on that same deposit.

The risk I take and the risk the firm bears and other clients take without their knowledge is much greater at higher leverage because it takes a much smaller market movement to wipe out my capital and put me into loss (or profit as may be the case) as the price of the asset I’m trading (say AUDUSD) moves up and down.

So along with excellent protocols to ensure no positions are ever let run over the deposit balance, it seems reasonable that the broker needs access to a certain amount of client deposited funds to adjust for the movements both positive and negative.

Under ASIC regulation 212 there are two specific provisions (RG 212.12 and RG 212.13) which allow for this client money to be accessed by the firm and the “licensee is entitled to the initial margin and any variation margin while the position is opened.”

That seems fair and at this point the client loses ownership of the funds – until credits are made back to the account.

But the kicker, which all clients need to be aware of, is that their deposits at the broker – even if they are held in a client segregated account – are pooled with those of other clients.

ASIC says:

An AFS licensee may use client money to meet obligations incurred by the licensee in connection with margining, guaranteeing, securing, transferring, adjusting or settling dealings in derivatives by the licensee, including dealings on behalf of people other than the client

ASIC tried to clarify the situation with RG 227: Over-the-counter contracts for difference: Improving disclosure for retail investors noting in RG 227.72 that:

In light of these risks, an issuer should develop a straightforward client money policy that includes a clear statement of how it will exercise any other permitted discretions in its use of client money.

This is ASIC-speak for a simple principle: people trading CFDs should be aware if their deposits are being pooled with other clients of the trading platform who might be taking on more risk.

There remains a risk that just like Opes Prime clients were unwittingly exposed to the bad trading of others when the loss making positions of a few clients were not closed out by the operators of Opes Prime. But, as a general principle, Deloitte’s Chris Campbell said as long as a broker “does their job” then client money should be safe.

Some in the CFD industry, like CMC Markets Asia Pacific Pty Ltd, GFT Global Markets UK Limited and IG Markets Limited believe that new industry standards need to be put in place to formally separate client funds from those of the brokerage house.

By virtue of the CFD Forum, which these three companies have established, they have lobbied ASIC, won approval from the ACCC, and are awaiting formal acceptance from the Finance Minister’s office of a new “best practice standards for contracts for difference”.

Included in these standards is a “formal” separation of client money away from the broker with membership of the CFD forum limited to those who, amongst other things, when it comes to client money agree that, “a member must not access money held in segregated accounts for ANY purposes, including using funds to hedge client trades or for its own operational purposes”.

Which of course seems entirely reasonable except that there is resistance in the industry to such a move with online forex brokers such as AXICorp telling the ACCC that:

The Standards that are proposed to be administered in accordance with the proposed Forum’s constitution and the Membership Rules do in fact contain exclusionary and cartel provisions and they give effect to those provisions. They are anti-competitive and constitute barriers to entry to the CFD industry by Australian companies. Furthermore, they are tainted by the apparent motives of the Applicants of improving or entrenching their own market positions in Australia.

The key to AXICorp and others objections seems to be that the industry is already regulated by ASIC under the individual licensees “AFSLs, Australian legislation and ASIC’s regulatory requirements and guidance”. As a result AXICorp says “The vast majority of the industry, therefore, does not support the CFD Forum’s standards as currently drafted which is why membership is not higher and representative of the Australian CFD Industry as a whole”.

That may be the case but it seems hard to argue that there shouldn’t be a formal separation of client and licensee money which minimises the chance of non-trading loses to clients.

After all trading and investment is often a hard enough business without having your money at risk through poor management of the brokerage a trader uses.

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