Will ASIC follow suit and impose a leverage cap on retail CFD brokers?

Will ASIC follow suit and impose a leverage cap on retail CFD brokers?

Andrew Saks

ASIC could well follow the FCA in capping CFD leverage to 1:25 for retail clients that have less than 12 months trading experience as part of its ongoing scrutiny of the CFD industry

Sydney Australia

By Sophie Gerber, Director at Sophie Grace and TRAction Fintech

In early December 2016, the United Kingdom’s Financial Conduct Authority (FCA) proposed leverage caps for retail CFD Brokers which will be dependent on the experience of the client. The proposal can be found in the FCA’s Consultation Paper CP16/40 entitled Enhanced Conduct of Business Rules for firms providing contracts for difference products to retail clients, which is open until March 2017. However most CFD brokers in the UK are anticipating that shortly afterwards, it will come into effect.

Following on from the FCA’s announcement, retail CFD brokers felt the effects of the proposed changes almost immediately. Some of the biggest players in the retail CFD industry found their share value dropped by at least 20%.

Now the question that the industry wants answered is, does the Australian Securities and Investments Commission (ASIC) have the power to implement the same leverage restrictions?

As ASIC draws on a variety of sources for its power, there are various mechanisms ASIC could use to restrict retail margin FX and CFD brokers in their dealings with clients, and there’s some that they cannot. We talk about the relevant ones below:

ASIC Powers

The Australian Securities and Investments Commission Act 2001 (the ASIC Act) sets out the powers of ASIC and its role in enforcement.  It covers unconscionable conduct, unfair contract terms and consumer protection (including misleading and deceptive conduct, pyramid selling, bait advertising, harassment and coercion, unsolicited financial services).  These concepts may alarm and may be relevant in the context of the Margin FX and CFD industry over the years, however such cases rarely end up in prosecution.

Importantly, the ASIC Act does not give ASIC any powers to impose rules in relation to leverage.

Regulatory Guides

The publication of Regulatory Guides by ASIC allows the regulator to provide guidance and commentary for financial service providers on how to interpret and apply the law to the functioning of their business.

Should ASIC decide to publish a new Regulatory Guide or update an existing one which documents a proposed leverage cap, the financial services industry will have a chance to review and respond on the contents before it is released in final form. This means that retail CFD Brokers would have the chance to respond ASIC’s proposals throughout the Regulatory Guide.

However, Regulatory Guides are not law. It is open to AFSL holders to interpret the law in a different manner. ASIC Regulatory Guides provide practical guidance on how the law should be interpreted but are not binding on the AFSL holder.

This however means that when challenged by ASIC, AFSL holders will probably have difficulty being successful in their justification of their legal interpretation and will have to take the disagreement to the Administrative Appeals Tribunal or a court to achieve success in justifying their position. This is definitely not the path of least resistance, and certainly an expensive one.

By way of example, ASIC’s Regulatory Guide 227 introduced a series of 7 benchmarks for the operation of margin FX and CFD businesses in Australia. Benchmark 2 is an example of a suggestion from ASIC regarding imposing an initial credit card deposit limit on clients of $1000. ASIC expects Retail CFD brokers to disclose in their Product Disclosure Statements (PDS) whether they are meeting each of these 7 benchmarks.

ASIC could implement an additional benchmark relating to leverage restrictions, however AFSL Holders would not be obliged to implement it.

Interestingly, ASIC reported on the retail margin FX and CFD sector’s compliance with the benchmarks in their Report 482 entitled Compliance Review of the Retail OTC Derivatives Sector published in June 2016.

The report advises that AFSL Holders that fail to meet a particular benchmark should disclose this in their PDS and detail the alternate measures they have implemented to mitigate risks that saw the establishment of the benchmark in the first place. Once again, this is ASIC’s interpretation of the Corporations Act requirements for disclosure (i.e. the PDS and Financial Services Guide), and is not mandatory for AFSL holders.

The Corporations Act

As per ASIC’s website, their duty is to carry out the work as specified in the Corporations Act. As the Corporations Act imposes legislative obligations on the financial services industry, ASIC may be able to lobby the Australian Government to amend the Corporations Act to impose a leverage cap on retail CFD brokers. This is much the same as what ASIC  have done with their suggestions for client money rule changes, however as established Australian players know, this process has been slow, and changes are not in sight until at least February 2018.

In order for leverage caps to be implemented under the Corporations Act, a product specific amendment to the Act would be required. This is something that has not occurred before for any other financial product and in our view would be extremely difficult for ASIC to achieve as it sets a dangerous precedent (something that would most likely meet resistance from the big banks and finance industry players) for product specific legislation into the future.

Product Intervention Powers

The Australian Financial Systems Inquiry introduced 44 recommendations for Government intervention into the financial sector. Of the 44 recommendations, 43 were accepted by the Australian Government, the final one being Product Intervention Powers. Recommendation 22 would allow the Australian Government and its Departments (ASIC) to ban or modify a financial product which has a high risk of consumer detriment. In the initial inquiry it was noted that the product intervention power would only be used as a last resort, however, with ASIC’s ongoing scrutiny of the retail CFD industry, the concern is that such an intervention could take place at any time and without warning. The financial services industry still awaits further information on whether this recommendation will be accepted.

Global leverage caps:

As ASIC generally models its regulatory stance on that of the FCA, the Australian retail CFD industry is waiting to see whether ASIC will follow suit and impose a leverage cap on all retail brokers. Most recently the FCA imposed:

  • A maximum 1:25 leverage for all retail clients who have 12 months or less CFD trading experience;
  • A 1:50 leverage cap for all retail clients; and
  • Lower leverage caps according to risks across a range of asset classes.

Interestingly, the above FCA cap follows on from the Cyprus Securities and Exchange Commission’s (CySec) leverage cap to all retail CFD brokers, where at the end of November 2016, leverage was capped at 1:50.

Sophie Gerber runs Australian compliance and legal consultancy business Sophie Grace Pty Ltd which specialises in assisting firms establish and maintain a financial services business in Australia.

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