Why the ASX failed to make ground in CFDs

Smart Investor magazine, December 2008

In November 2007, the Australian Stock Exchange launched a series of contracts for difference called ASX CFDs. It had seen the growing interest and volumes in CFDs from the wave of London-honed providers like CMC and IG Markets who had brought the industry to Australia, and it wanted in on the act.

The ASX made some compelling arguments about why traders would be better off with an ASX product. It started by stressing market independence. “As the central market operator, ASX is independent of the parties with whom you are receiving advice and dealing through, enabling it to act fairly and impartially,” it said then (and still does, on its web site). “Having a central market also means there is one standard contract specification for all ASX CFDs, not a different product depending on who you execute through. It’s a fundamentally better CFD market.”

The ASX also claimed going through its products would involve greater transparency than its peers, and that using the ASX trading model – where your order is entered directly into the ASX CFD central market order book, available for all the market to see, with orders executed on a strict price and time priority basis – is better for customers than trading on the over-the-counter (OTC) markets through other providers . ASX offered, in essence, “the key features of existing CFDs augmented with the fundamental strengths of exchange-based trading.”

The problem is, nobody seems to have listened. The ASX’s annual report covering the financial year to June 30 2008 says that total CFD markets between the November launch and June 30 were 50,772 with a notional value of A$1.561 billion. Any provider should be granted a slow start, but to put it into context, CMC Markets handled 1.1 million trades in September alone; it is estimated that the notional value of CFD trades in total was about $400 billion in 2007 and is probably going to be up by at least half this year.

Investment Trends, the research group, recently published a detailed study of the CFD market in Australia and found that only 4% of CFD traders used the ASX CFD model the most – and that these were typically less frequent traders. “Only around 1% of the total volume of CFD trades [is] through one of the implementations of the ASX CFDs service,” the report says.

What’s the problem? Rival providers talk about liquidity problems, argue that prices are too wide, and that there is a challenge with distribution through stockbrokers who aren’t necessarily familiar with the product. “Most people gravitate to a specialist,” one says.

In fact, brokers who are nominated to provide ASX CFD broking services include some of the biggest names in the market, among them CommSec, Bell Potter and Morrison Securities, so it’s drawing a long bow to claim groups of this stature wouldn’t understand what they are selling. But there is perhaps a question of how much attention the products get from these brokers.

Nevertheless, there is something in the ASX’s claim that an exchange-traded market is better for the investor than the OTC market, if only because it provides a bit more transparency and stability in uncertain times. The lesson seems to be that investors either haven’t cared about that or haven’t heard about it, whereas the marketing of the highly sophisticated and well-thought-out CFD platforms from the big providers has been aggressive and successful.

A closer look at the Investment Trends survey backs this up. It asked what people’s preferred method of access was, and why. 59% preferred direct market access, 17% market makers, and only 5% the ASX. Tellingly, 17% – three times as many as opted for the ASX – didn’t know the difference. And while those who like the ASX method cited transparency, security and familiarity, transparency was also mentioned as a key reason people preferred direct market access, suggesting that they certainly don’t see a problem there. The other reasons people preferred direct market access were real time prices and their trust of those prices – the crux of the matter for CFD traders.

The slow start hasn’t tempered the enthusiasm of the ASX to press on. The annual report says: “We are also planning on listing a second generation of CFD products… The new listing initiative targeted at attracting unlisted funds and structured products onto the exchange’s platforms is awaiting regulatory approval… we anticipate a launch in the first half of FY2009.” Perhaps they’ll have more luck there.

CHART (Please make a pie chart out of this)

Preferred methods of trading CFDs

Direct market access: 59%

Market makers: 17%

ASX: 5%

Don’t know the difference: 17%

Other: 2%

Source: Investment Trends