We are all waiting for the fallout from CFD provider, Sonray Capital Markets Pty Ltd, going into Administration last week. Reports are coming through that some clients have been left in the same legal position as clients of Opes Prime and Lift Capital. ASIC has been focusing on CFD providers for some time, since they are not regulated as strictly as ASX Participants. ASIC required CFD providers to place client deposits into a segregated account, so that the funds were not at risk from margin calls made on the Companies. Administrators are saying that it is not totally clear whether the segregated funds were protected until a full investigation has been made.
With CFD's, when you buy a CFD Share, you are not getting any legal entitlement to own those particular shares. Placing money on deposit, unrealized profits, and any interests in the CFD portfolio, the legal and beneficial title to those assets are transferred to the Provider. The client then ranks as an unsecured creditor. This was the same situation as Opes Prime and Lift Capital. It got to the terrible situation where a client had lodged stock, not drawn down a margin loan, but lost everything because their assets had been transferred to those margin lenders.
CFD's are quite a lucrative business. With one provider, you can place a $5,000 deposit to purchase CFD shares. With a 5% margin requirement, you could buy up to $100,000 of shares. You don't earn interest on the $5,000 deposit, but you pay 7.5% (RBA plus 3%) on the full face value of the $100,000 CFD shares. If the shares go up in value to, say, $110,000, you are then charged interest on $110,000. Even though the $5,000 is placed in a segregated account, according to the Product Disclosure Statement, the unrealized profit of $10,000 is specifically not segregated.
If another client shorts the same $100,000 of shares with a similar 5% deposit, the client receives 1.5% (RBA less 3%) return on the value of the shares shorted, and similarly receives no interest on the deposit. One client has purchased shares, another has sold, so the CFD provider is not holding any shares. But they are charging 7.5% on a $100,000 balance and paying 1.5% on the same balance. Therefore, they earn 6% on purely a notional balance. They also don't pay interest on $10,000 initial deposit placed by the clients. The money is in the money, to try and run as large an offsetting book as possible. This is not to say CFD providers don't have capital, they do. I am also sure that they would have robust risk management systems such that they have minimal market exposure. What is not published is how much counter party risk they have to clients.
If clients have purchased positions worth $100m, and other clients have shorted positions of $100m, they clearly have no risk to a free fall in the market. What they do have a risk to is the clients that have purchased positions, who now are out of pocket $40m, if the market falls like it did in October 1987 (XAO from 2253 to 1334). What we need is the regulators to tell us that the CFD companies have the capital, the risk management, and systems to survive a stress test.
Providers have varying different models, where some do pay interest on deposits, the interest rate spread is less than RBA +/- 3%, and some have large capital positions. What we don't know is whether the Capital is adequate.
When you buy shares on the ASX, you are providing with a HIN such that you are the registered beneficial owner of those shares and you registered on the listed companies' share register. The ASX participants are closely scrutinized by ASX/ASIC to ensure sufficient capital and risk management exists. Client monies can be held in a bank account, with the full protection of the Government Bank deposit guarantee.
As I said, you ain't got a thing, unless you got a HIN.
Update: 2nd July 2010 - The Age - CFD must read ......(in part) Since Sonray collapsed just over a week ago, BusinessDay has been inundated with calls and emails from clients who are stunned that their accounts have been frozen and that they are now unsecured clients. One said: "I have an account with Sonray that has been frozen. My account had $5000 in it and I am unable to withdraw my money or place trades. I also have an account with another CFD provider They told me that it was held in a client trust account I sent them a withdrawal request for my $180,000. They told me it would take up to five days to process because the money would have to be called back from their counterparty as they did not have it any more. So much for holding it in a trust account. I am really worried about the ethics of these guys. It seems like they are trying to hide something. Hopefully I will get my money back and then I'm out of there before I have another Sonray on my hands, but this time it's not $5000 but $180,000."