The ‘financial heroin’ product that ASIC is trying to bust

When a Federal Court judge refers to the investment product Contracts for Difference (CFDs) as “financial heroin hits”, it’s an attention grabber.

For an investor, a win represents a massive high. But if you lose, withdrawal is financially painful.

The market watchdog is essentially attempting, rightly, to save investors from their unsophisticated selves.Credit: Darrian Traynor

The most vulnerable are unsophisticated retail investors – 77 per cent of which will lose money, according to a warning on the website of broker eToro. The firm was sued by the corporate regulator on Thursday over alleged deficiencies in its sales pitch to tens of thousands of mum and dads.

It was back in 2020 that Federal Court Justice Jonathan Beach was so drastically highlighting the risks of investing in CFDs as he fined three trading firms $75 million for engaging in unconscionable conduct.

But the regulatory war on CFDs – a derivative product that rates at the very high end of the risk and complexity scale – rages on.

The product allows investors (that I liken to punters because the odds are worse than playing black jack) to bet on the movement of company shares, foreign exchange rates, commodities or crypto assets.

The particular sting with CFD is that they are highly leveraged and investors can lose a multiple of their investment.

In its latest bust, the corporate watchdog has launched court action against eToro, alleging it failed its licence obligation to act efficiently, honestly and fairly in marketing and distribution.

eToro, a major sponsor of the Wallabies, is one of several firms that the Australian Securities and Investments Commission has targeted this year. It has also issued stop orders against Mitrade and Saxo Capital for issues around CFDs and retail investors.

ASIC’s beef isn’t so much about the actual product, and there is no suggestion that it’s a scam.

For an investor, a win represents a massive high. But if you lose, withdrawal is financially painful.

It’s about whom the CFDs are marketed to and how they are marketed.

ASIC maintains that brokers need to screen out the retail investors that can’t really understand what they are investing in.

The market watchdog is essentially attempting, rightly, to save investors from their unsophisticated selves.

Incidentally, Australia is said to have more CFD investors per capita than almost anywhere else in the world, according to one recent report from Financial Magnates Intelligence.

eToro is a major sponsor of the Wallabies.

ASIC alleges eToro’s target market for the CFD product was far too broad for such a high-risk and volatile trading product where most clients lose money.

(A spokesperson for the firm said that the regulator’s proceedings related to a time period between October 2021 and July 2023, and that it was now operating “with a revised target market definition” for CFDs.)

In its claim, the market watchdog found eToro’s screening test totally inadequate to assess whether a retail client was likely to be within the target market. Indeed, this was a screening test that was really hard to fail.

If a retail client scored 5 or more out of a total possible score of 41, the client was permitted to trade in the CFD product (although if they scored from 5 to 20, they were required to view a risk disclaimer before commencing such trading).

ASIC said in its statement of claim that a retail eToro client would only fail the risk test if their trading strategy purpose was “future planning” or “saving for home”, and their attitude to risk was only accepting losses “to minus 3 per cent”, their net annual income was less than $200,000 and their total cash and liquid assets were less than $200,000.

If they said yes to three out of four answers, they still passed. On another of eToro’s screening tests, investors that scored five or more from a possible 41 were still able to invest.

ASIC contends that clients could amend their answers without limitation and clients were alerted if they selected answers which could result in them failing.

But for most small investors, the eligibility test to buy CFD is one they would do better failing.

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