The Australian Securities & Investments Commission is often referred to as Australia's chief investments watchdog for good reason.
Because, in its primary role of overseeing many aspects of Australia's corporate and financial landscape, ASIC is known to bite if it believes investors are being put at risk.
That's why, just before Easter, the regulator made separate announcements on two heavily marketed, high-risk investment products – contracts for difference (CFDs) and binary options.
CFDs and binary options are different types of investment products, but they both allow investors to speculate on future price movements.
According to ASIC, the other main thing these products have in common is that a large percentage of the retail investors who have used them in the past have ended up losing their money.
During a five-week period in March and April of last year alone, ASIC investigations found that the retail clients of a sample of 13 CFD issuers in Australia had collectively lost more than $774 million.
Separately, ASIC has estimated that Australian investors in binary options lost almost $500 million in 2018, and close to $7 million in 2019. It hasn't yet released data on 2020.
Behind ASIC's interventions
ASIC has been looking into both types of products for some time – in fact for several years.
Its reviews in 2017, 2019 and 2020 found that most retail clients lose money trading CFDs. ASIC also conducted reviews of binary options in 2017 and 2019 and found that about 80 per cent of retail clients lose money trading them.
Last year ASIC released a consultation paper recommending restrictions on the sale of CFDs as well as a total ban on binary options. Those recommendations have now taken shape.
On March 29, the regulator advised that a product intervention order on CFDs, including tight conditions on their issue and distribution to retail investors, would come into immediate effect.
Then, on April 1, it announced a ban on the issue and distribution of binary options for 18 months, from the start of May. After then the ban may be extended or made permanent.
The maximum penalty for a contravention of a product intervention order is five years' imprisonment for individuals and substantial pecuniary penalties of up to $555 million for corporations.
How CFDs work
At a basic level, CFDs allow investors to speculate on short-term movements in share prices, foreign exchange rates, share market index levels, or changes in the prices of other assets including commodities such as gold.
For example, contracts can be taken out that are based on whether a company's share price will rise or fall by a certain amount over a specified time period.
Gains or losses depend on the price of the underlying asset when the contract starts and ends.
If the price contract moves in your favour, then the CFD provider is obligated to pay you. But if the price moves against your contract position, then you're legally required to pay the CFD provider.
Probably the riskiest feature of CFDs is their ability to provide leveraged exposure. That essentially means you only need to put down a small amount of your own money and can substantially magnify your position by "borrowing" the rest.
For example, you may only have to put up $5,000 for a $100,000 contract. You are effectively borrowing the other 95 per cent. A 5 per cent change in the underlying asset price could mean you lose your initial $5,000 and may need to make further payments to cover your total position.
Up until now investors have been able to take out CFDs on foreign exchange bets that leverage their initial outlay by up to 500 times. That is, a $1,000 contract could have provided up to $500,000 of risk exposure.
ASIC's new intervention order means the maximum leverage available to retail clients will now range from 30:1 to 2:1, depending on the asset class underlying the contract.
ASIC's order restricts CFD leverage offered to retail clients to a maximum ratio of:
30:1 for CFDs referencing an exchange rate for a major currency pair. A major currency pair means any two of the Australian dollar, British pound, Canadian dollar, euro, Japanese yen, Swiss franc and U.S. dollar;
20:1 for CFDs referencing an exchange rate for a minor currency pair (any pair that is not one of the major currency pairs), gold or a major share market index such as the S&P 500 or S&P/ASX 200;
10:1 for CFDs referencing a commodity (other than gold) or a minor share market index;
5:1 for CFDs referencing shares or other assets; and
2:1 for CFDs referencing crypto-assets.
How binary options work
Binary options are financial products that also allow investors to bet on movements in share prices, currencies or financial markets.
They're also known as "all-or-nothing options", because one of the two possible outcomes for a binary option contract is that you'll lose your entire investment amount.
In other words, it's a 50:50 flip of the coin whether your investment will win or lose.
ASIC notes that while picking which way a share price or currency may move in a short period of time may sound simple, it's actually extremely difficult, even for professionals.
But a key difference between CFDs is that binary options investment plays can be over extremely short periods, ranging from just a few minutes to hours.
The average contract duration of binary options traded with one provider is less than six minutes.
"Binary options' product characteristics make them incompatible with investment or risk management use by retail clients," ASIC said in its April 1 statement.
"ASIC's product intervention order will protect retail investors from these harmful products at a time of heightened vulnerability."
With any investment product, it's always important to understand exactly how they work and what you're ultimately investing into by reading its Product Disclosure Statement and other supporting materials.
Vanguard Australia