Background
ASIC recently released Report 579: Improving practices in the retail OTC derivatives sector. The report identifies some of ASIC’s key issues and concerns with the sector, which services more than 450,000 clients, 97% of whom are retail clients.
The sector sees annual turnover of approximately $11 trillion, with the majority of turnover in Margin FX, and holds more than $2 billion in client money.
ASIC’s concerns
Having reviewed 57 OTC derivative issuers, ASIC has raised a number of concerns with industry practices, including:
use of misleading marketing materials;
unclear pricing methods;
poor and inadequate risk management practices;
potential breaches of legislative restrictions on referral selling; and
inadequate monitoring of counter and related parties.
ASIC considered the use of vague, ambiguous and potentially misleading marketing materials and the impact this can have on retail clients unaware of the risks associated with the products they are investing in.
The report also cited the following figures, showing that the majority of traders in OTC derivatives are unprofitable:
63% of Margin FX traders;
72% of traders in Contracts for Difference (CFD); and
80% of traders in binary options.
ASIC reported on the unprofitability of binary options traders and binary option issuers’ continuing obligations to ensure that their clients are aware of the pricing and risks associated with such products.
ASIC also noted that cryptocurrency CFDs are now being offered in Australia, and cautioned that the prices of these products are extremely volatile due to volatility of the underlying cryptocurrencies, which is magnified by leveraging.
Risk management is also addressed in the report, with ASIC calling on product issuers to review their risk management strategies and exercise proper oversight over related parties. As an example of the difficulty product issuers may face in balancing risks, ASIC notes that while market risk can be reduced by hedging the risk with another party, this increases counter-party risks. On the other hand, holding all risk internally increases market risk.
ASIC has flagged that issuers which pay referral fees on a commission or volume basis risk breaching the prohibitions on conflicted remuneration and referral selling. Referral arrangements must be compliant with financial services law.
Finally, with new client money rules coming into force on 4 April 2018, ASIC has also taken the opportunity to remind OTC derivative issuers of their obligations with respect to client money.
Takeaway
With developing markets such as cryptocurrency interacting with the more established practices of margin foreign exchanges, CFDs, and binary options, ASIC is seeking to ensure that retail clients are aware of the volatility in markets, the risks associated with such investments, and there is full disclosure of the pricing and costs of products before they are entered into.
Product issuers’ marketing and disclosure material, risk management framework (particularly in respect of counterparty risk), handling of client money and referral arrangements are identified as areas of concern in how the industry operates. Inadequate or non-compliant systems represent a significant risk to a product issuer’s AFSL and business, and should be regularly reviewed, monitored and updated.
ASIC has indicated that it is focussed on acting to protect the integrity and public confidence in the OTC derivatives market. ASIC will be working with industry to raise standards and practices to ensure the integrity of the market moving forward.
If you are unsure about your obligations or need assistance in reviewing and updating your compliance systems, please contact Richard Beissel or Hillary Ray of our Financial Services Team