The Hayne Royal Commission recently shone a light on the issue of responsible lending practices and in turn recommended measures intended to improve the process by which banks and mortgage brokers provide financing to home buyers and small businesses.
An equally significant, but lesser known issue exists within the broking industry in Australia and it involves the amount of leverage being provided to retail investors who trade in Contracts for Difference (CFDs) and Foreign Exchange (FX).
In early April the Australian parliament passed the Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Bill 2019 thereby allowing ASIC to impose responsible leverage limits on products issued to retail investors. Importantly, Australia has now aligned itself with its international peers given the European Securities and Markets Authority (ESMA) imposed leverage limits on CFD & FX trading for retail investors in July last year, in turn bringing Europe into line with similar restrictions already in place in Singapore, Hong Kong and Japan.
The ability to trade CFDs and leveraged FX instruments are an important part of the Australian investment landscape as they bring a number of significant advantages for retail investors. They open the door to increased diversification opportunities, allowing clients to trade the full global macro cycle, and retail investors to hedge their market exposure in a flexible and efficient way, and in doing so it democratises access to investment opportunities that have long been the domain of institutional investors.
Most CFD & FX brokers offer trading on a leveraged basis. This means that clients can use either a cash deposit, or existing shares, to trade larger sums on margin – effectively they need only a small amount of capital in their trading account to establish bigger positions.
In this way, leverage can magnify any gains the investor makes, but the reverse is also true in that it can magnify losses. Small movements in the underlying investment – whether it be a stock index, an individual company’s shares, a commodity or a currency – can result in larger gains or losses for the investor that are proportional to the amount of leverage taken.
Saxo Group does not offer its clients irresponsibly high levels of leverage and is concerned that parts of the margin trading industry are insufficiently focused on protecting clients’ interests as they offer leverage that can result in significant client losses.
Saxo welcomes the successful passage of the legislation in Australia and ASIC’s increased product powers because up until now Australia has been a global outlier when it comes to the excessive leverage levels being provided to retail investors.
Retail investors in Australia are able to access leverage ratios as high as 500 times to 1 by major CFD providers, meaning that clients need only put up $1 to trade $500 worth of exposure. This is an extremely risky position because the underlying investment need only decline by 0.2% for the clients to lose the full value of their invested capital.
Even with 1 to 200 leverage, a position need only move 0.5% in the opposite direction for client to have their trade stopped out. As we know, markets do not move in straight lines so there is a real risk, that at these levels of leverage a client may actually make the right market call but still lose the value of their investment. That is why avoiding unnecessary stop-outs, where possible, is crucial to being successful in trading and investing in leveraged products and why leverage caps are a very effective risk mitigant in protecting the value of client accounts.
By way of comparison, a leverage ratio of 20 to 1, indicates that the underlying investment needs to fall by as much as 5% before a client will lose their capital - a much more conservative risk profile.
Under the current European Securities and Markets Authority (ESMA) rules, CFD brokers in the EU can offer clients leverage of no greater than 30 times to 1 for major currency pairs, 10 times to 1 for commodities and 5 times to 1 for individual equities.
At Saxo Capital Markets, we believe in responsible leverage and take a much more conservative approach than many other market participants. We are currently offering 25 times to 1 on the Australian dollar, which is in line with the ESMA standard.
Interestingly, since the rules were changed in the EU, several European brokers who were servicing customers in China, Indonesia and Eastern Europe had started onboarding clients in Australia in order to retain their ability to offer high levels of leverage. These operators formed a group to lobby ASIC and were proposing to allow “self regulation” of the industry on this issue. Clearly self-regulation would not have delivered Australian retail investors the protections they require. So whether we are talking about the provision of financing for residential mortgages or trading and investment products, responsible levels of lending are now a very real consideration for all leveraged product providers – and this is a good thing for clients and the industry.
We look forward to seeing ASIC’s product intervention powers being implemented in practice as we believe they will ultimately deliver stronger protections for Australian traders and investors wishing to trade CFDs and other leveraged products.
Adam Smith, CEO of Saxo Capital Markets, Australia
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