Manipulation of the CFD market in Australia? Eat porridge for two years

Australia is widely recognized internationally as a nation with a very well organized and diverse retail electronic trading sector.

The Antipodean economic giant is home to several very well established Australian FX & CFD brokerages, as well as very substantial divisions of Britain’s most prestigious retail electronic trading entities.

Perfectly positioned as a Western nation with a social, business and government structure which harks back to the British colonial period, its top quality ethics and commercial acumen recognized by the West, and its local neighbors in the surrounding Asia Pacific region, Australia’s standing is benchmark level in the FX industry.

In order to maintain this, the regulatory structure, administered by the Australian Securities and Investments Commission (ASIC) has led the way for several years, being one of the only government-operated regulators of non-bank financial services that truly understands our business properly and is technologically advanced enough to conduct real time surveillance on brokerage activities.

This, combined with the genuine will to do things properly that exists in Australia, goes a long way and has resulted in some very stringent activity toward those who infringe.

ASIC has made its perspective clear with regard to CFD trading conditions several times, this being important due to the prevalence of CFD providers in Australia, however today another action against a trader has taken place.

Stefan Mark Boitcheff of South Australia, has been convicted and sentenced after pleading guilty to two market manipulation-related charges in the District Court of South Australia.

Mr Boitcheff was last week sentenced to one year and nine months imprisonment, with an order that he be released immediately upon entering into a recognisance to be of good behaviour for two years.

ASIC Commissioner Cathie Armour said in a public statement today, ‘Any form of market manipulation undermines the integrity of our financial markets and creates an uneven playing field. It is important that markets operate fairly and that people who attempt to deliberately interfere in that process are brought to account’.

Mr Boitcheff pleaded guilty to two charges in respect of the following conduct:

• between 3 January 2013 and 16 July 2013, carrying out 112 transactions in CFDs relating to Anteo Diagnostics Limited (ADO) shares which had the effect of creating an artificial price for trading in ADO shares on the ASX; and
• between 8 May 2013 and 7 January 2014, carrying out 4 transactions in CFDs relating to ADO and in the shares of ADO, that had the effect of creating a false or misleading appearance of active trading in ADO shares on the ASX.

Brokers in Australia which have the mettle and resolve to ensure quality of CFD provision in a long term and sustainable fashion fully understand the framework they are working under.

The majority of equity CFD providers look to offer a relationship along the lines of a traditional brokerage, acting as an agent on behalf of their clients. In other words, they are not risk-takers but instead look to hedge their CFD transactions in the underlying cash market.

So if a client was, for example, to submit an order to buy 10,000 CFDs in a company’s stock, the provider would simultaneously enter the market, buy 10,000 shares in that particular company as a hedge, and write a CFD to the client at the same price.

In this way, the client receives the position that he wants, namely long 10,000 CFDs in that particular company, while the provider has hedged his short CFD contract with the client by buying stock in the market. Although counterparties to the CFD transaction, the fact that the CFD provider is hedging means that any price improvement can be passed on to the client, who as a result pays the best cash market price.

For this reason, the relationship between the client and CFD provider is crucial, as traders need transparent prices that track the cash market without any delays, and with firms that do not have specific relationships with institutional providers, pricing what can be construed as an off-exchange futures contract is a very significant challenge.

In order to offer correct CFD pricing that can be properly verivied, late last year, CMC Markets, one of the most prominent CFD providers in the Australian market, entered into a strategic partnership with FlexTrade, a company whose FX execution management system accesses more than 70 liquidity providers.CMC Markets has considered the need to provide a fully comprehensive order execution management solution for CFDs, and has during the past few months concentrated on expanding its ability to provide full pricing information to clients.

Operating with banks, ECNs and exchanges, FlexTrade is a broker-neutral, execution and order management trading systems for equities, FX, options, futures and fixed income securities. Last year, FlexTrade opened an office in Sydney Australia, in the heartlands of the country’s major market center for CFDs.

In September last year, FinanceFeeds spoke to Richard Elston, Head of Institutional at CMC Markets. When asked what the partnership will do to enhance the trading environment, Mr Elston explained

“The partnership has been designed to ensure clients – like aggregating brokers and smaller, emerging hedge funds – have the best possible access to the widest range of asset classes. Forex has always been well established, but we’re now in a position to offer our Indices, Commodities and Treasuries CFDs to institutional clients right alongside currencies. This affords clients real flexibility” – Richard Elston, Head of Institutional, CMC Markets

Recently, in Sydney, FinanceFeeds met with Christopher Gore, CEO of Australian retail trading company Go Markets, who expanded on this subject “While jurisdictions such as Australia and the United Kingdom are well regarded from a regulatory point of view, locally I think we’re still only part way through the regulatory transformation.”

“My view is that we are at an important time – a squeezing if you like – which may promote consolidation and perhaps even a couple of exits in their various forms.  Earlier this week we saw the ASICs reporting rules finalized which was highly anticipated by industry. It was good to participate in the consultation process, and to their credit, they asked the industry for our feedback and took on board our suggestions” – Christopher Gore, CEO, GO Markets

The regulatory curve after critical events

“The regulatory curve has clearly steepened as a result of critical events in recent years such as the GTL default” said Mr Gore.

“The by-product of this is of course increased regulatory surveillance, enforcement outcomes, and more generally, a much higher barrier to entry. These events have shaped, and will continue to shape, the industry in Australia as we know it. All of these factors are in some way culture changing, where licence preservation becomes one of the most critical parts of a business and key to achieving your commercial objectives. A solid compliance framework promotes longevity” he explained.

It does certainly appear that after the GTL Trading episode, ASIC clamped down very harshly. It became very clear that almost all license applications for retail FX firms were stopped by ASIC with rumors that some were taking more than a year to process, whilst applications for AFS licenses from other financial services businesses in other sectors were being processed without delay. It is an interesting point whether this was an overly cautious move, or one to preserve Australia’s standing.

Australia used to be a region in which a $30,000 license could be sold for as much as $250,000 in cash due to demand and desire for incoming firms not to wait out the application process, and this is currently a very gray area.

“I do hear occasionally about the ‘going rate’ of financial services licences. I guess this is a ‘grey market’ of sorts that’s a product of an apparent slowing, or halt, of new licences. Still, I would say that while a license may fetch a pretty penny, there are no quick wins and I would imagine an extensive list of regulatory hurdles to jump once you get your hands on it” stated Mr Gore.

In this particular case against day trader Mr Boitcheff, CFD trading accounts were operated on a direct market access model, under which the CFD issuer hedged its exposure to a client’s trading position by causing a direct and equivalent position to be taken in the underlying security on the ASX. This hedging mechanism can result in CFD trades having an immediate impact on the underlying shares being traded on the ASX. The CFD issuer’s clients are able to see the CFD positions translate to an actual buy or sell order in the underlying shares on the ASX.

ASIC has recently taken a number of market manipulation actions involving CFDs.

In June 2014, Kristoffer John Watts was sentenced in the Brisbane District Court to two years imprisonment, with 21 months of the sentence suspended, and three months imprisonment to serve, following pleas of guilty to three charges of market manipulation involving trading in direct market access CFDs. (refer: 14-131MR).

In September 2015, Nigel Derek Heath was sentenced in the District Court New South Wales to two years and three months imprisonment, to be released after nine months on a recognizance release order, following pleas of guilty to two charges of market manipulation involving trading in shares and CFDs. In February 2016, the Court of Criminal Appeal in Sydney upheld an appeal by Mr Heath against the sentence imposed on him by the District Court in September 2015. (refer:16-051MR).

In December 2014, ASIC accepted an enforceable undertaking from First Prudential Markets Pty Ltd, a provider of direct market access CFDs, relating to concerns about its compliance processes for detecting and dealing with potentially manipulative client trading. (refer: 14-345MR).

James O’Neill, Director of ILQ Australia Pty recently explained

In my view, ASIC’s regulatory omission of rules dealing with fair market pricing is left wanting. Similarly, CySec’s rules on fair market pricing are also inadequate and are potentially damaging to CFD issuers if followed assiduously. CySec’s rules effectively prohibit negative slippage.

Over a prolonged period of time and in a market full of scalpers (clients whose trading strategy is to ‘hit’ brokers off-market) this could result in the bankruptcy of brokers. The author commends the NFA and FCA for their rules on fair market pricing. Though, different in their approach, both operate to ensure that brokers can operate within the general market while prohibiting nefarious behaviour when it comes to pricing of the financial instruments. – James O’Neill, Director, ILQ Australia Pty

“CFD providers will generally quote bid and offer prices at which the provider is willing to enter into long or short contracts with clients over an online platform” said Mr O’Neill in his definition to FinanceFeeds. “Industry practice dictates that this margin amount is quoted as a ratio, for example a 2% margin is quoted as 50:1.”

Mr O’Neill concluded that the Australian market is dominated by two providers, IG Markets and CMC Markets who combined, make up 56% of the market, and that the Australian component of FX & CFD volume is sizeable and growing with total average daily volumes across over-the-counter (OTC) markets amounting to $134.8 billion in April 2016.

With the ability for ASIC to actually enforce jail sentences and company wind-ups on those who infringe, the nation remains one of the only genuinely well regulated environments outside North America for electronic trading. Expensive, yes, but a very good strategic jurisdiction with the right talent and a willing client base whose peace of mind is unrivaled in the region.