Order up! ASIC expands its menu of product intervention orders

7 minute read 27.10.2020 Richard Batten, Prayas Pradhan, Ian Lockhardt, Michael Lawson, Martin Wright, Nicole Riethmuller, Nicole Brown

ASIC made a product intervention order on 22 October that imposes conditions on the issue and distribution of contracts for difference (CFDs) to retail clients. We've summarised the key aspects of the order and provide our take on the implications.

ASIC made a product intervention order on 22 October that imposes conditions on the issue and distribution of contracts for difference (CFDs) to retail clients.

A CFD is a contract on the difference between the opening and closing price of an asset. It is typically a leveraged derivative contract that allows a client to speculate in the change in value of an underlying asset, such as foreign exchange rates, stock market indices, single equities, commodities or cryptoassets.

The order comes after the regulator indicated that CFDs have resulted in significant financial losses to retail clients, demonstrated by the proportion of retail clients' trading accounts that lost money trading CFDs and the quantum of financial losses to retail clients.

This represents the second product intervention order made by ASIC but there remains numerous proposals to make orders in respect of other products that ASIC consider cause significant consumer detriment – and that catalogue of orders may further expand with ASIC keeping a close eye on the financial behaviour and impacts on retail clients during the COVID-19 pandemic, and that of financial services institutions.

Background to the CFD order

In August last year, ASIC released Consultation Paper 322 Product intervention: OTC binary options and CFDs (CP 322) to seek feedback on ASIC's proposals to introduce an order to address significant detriment to retail clients resulting from over-the-counter (OTC) binary options and CFDs. ASIC received over 400 responses to the paper.

In the recent Federal Court decision of Australian Securities and Investments Commission v AGM Markets Pty Ltd (in liquidation) (No 4) [2020] FCA 1499, Beach J referred to the paper in coming to the decision to impose a pecuniary penalty on a number of the defendants (for a total of $75 million) for engaging in a system of conduct that was unconscionable in relation to the provision of OTC derivative products to retail investors in Australia.

In the decision, his Honour said, '[i]f I may say so, there is considerable merit in ASIC’s proposal, but of course these are policy matters outside my realm of influence. But what I can say is that if such measures had been in place, most of the egregious conduct and its consequences that was exposed in the present case would in all likelihood not have occurred.'

His Honour also indicated that the proposed changes were 'likely to result in a reduced risk of similar conduct being repeated in the future by other market participants or at least significant ameliorate its scope or effect'.

Effect of the order

In summary, the order:

imposes conditions on issuing and other specified dealings in CFDs with regards to retail clients;
prohibits giving or offering specified benefits to retail clients or prospective retail clients in specified circumstances; and
requires CFD issuers to take reasonable steps to notify their retail clients of the terms of the order.

The conditions and prohibitions have a staggered commencement date. The limits on leverage ratios, the protections on margin close-outs and negative balances, and the prohibition on inducements all commence on 29 March 2021. More immediately, the order requires a CDF issuer that has issued a CDF to a retail client in the 12 months before commencement of the order which would be covered by the conditional prohibition in the instrument to take reasonable steps to notify each such retail client of the terms of the instrument as soon as practicable and within 10 business days after commencement of the instrument.

There are a few key changes to the order as compared to the proposal in CP 322:

the ‘margin close-out protection’ now provides for calculation by reference to the total margin;
the prohibition on inducements now expressly prohibits rebates or carve out discounts of fees and costs;
CP 322 proposed certain risk warnings and disclosure measures which have not been included in the order; and
the final order sets out jurisdictional scope – that is, it applies where a CFD issuer is a body corporate incorporated or carrying on a business in Australia, or an Australian citizen or ordinarily resident in Australia. The draft order released with CP 322 did not expressly refer to this.

ASIC’s consideration of feedback on its proposal in CP 322 to ban the issue and distribution of binary options to retail clients is also ongoing.

The catalogue of ASIC’s product intervention orders is expanding

The introduction of the CFD order follows a year in which ASIC has increasingly sought to exercise its ‘new’ power to make product intervention orders pursuant to Part 7.9A of the Corporations Act 2001 (Cth) and Part 6-7A of the National Consumer Credit Protection Act 2009 (Cth). Regulators in the US, the UK, the European Union, Hong Kong and Taiwan have similar product intervention powers.

The product intervention powers came into force in April 2019 and ASIC first used its power by making an order in September 2019 to ban a model of short term credit lending.

Shortly thereafter, ASIC began consultations in October 2019 on a draft product intervention order intended to address consumer detriment arising from the distribution of add-on insurance and warranties by caryard intermediaries (see CP 324). In response to those submissions, ASIC made a number of changes to the proposed product intervention order and invited stakeholders for feedback again in August 2020 (see ASIC 20-179MR).

In addition, in June 2020 ASIC released a new regulatory guide on the administration of its product intervention power (see Regulatory Guide 272: Product Intervention Power) and in July 2020 ASIC sought public input on a proposed intervention order in relation to continuing credit contracts (see CP 330).

ASIC noted that in finalising its guidance in RG 272 it considered the judgment in Cigno Pty Ltd v Australian Securities and Investments Commission [2020] FCA 479. That case related to a judicial review application by Cigno to challenge ASIC’s product intervention order in respect of a short-term credit product. Cigno’s application was dismissed with costs awarded to ASIC but matter is subject to appeal.

Accordingly, we can clearly see that the product intervention power has and will be an important addition to ASIC’s regulatory toolkit and that ASIC’s ‘menu’ of orders will only expand in the immediate future.

Protecting the vulnerable, particularly with COVID-19

A power to ban and impose conditions on financial and credit products when there is a risk of significant consumer detriment is naturally going to lend itself on protecting consumers that are in most need of such protection.

ASIC’s decision to exercise its power in relation to short term credit lending came after market surveillance in which it found the fees combined under the short-term lending model could add up to almost 1000% of the loan amount. ASIC also noted that consumers who use such products are often from low socio-economic backgrounds and/or are experiencing financial stress and using the loan to pay for basic expenses such as food, bills, and car-related expenses.

In addition, both the public notice for the CFD order and the consultation paper for the continuing credit draft order refer to the ongoing effects of COVID-19 on the market.

The former refers to 'heightened market volatility during the COVID-19 pandemic' in relation to an explanation that between 16 March and 19 April 2020, the proportion of CFD issuers' retail clients' trading accounts that lost money trading CFDs each week ranged between 56.9% and 63.2%. That surveillance also follows ASIC reviews in 2017 and 2019 in which it found most retail clients lose money trading CFDs.

The latter outlines an increase in unemployment (as at May 2020) that has caused ASIC to be concerned that 'there may be a further increase in demand by retail clients for this class of financial product, which may result in additional significant detriment'.

Accordingly, it would appear that ASIC has been seeking to exercise its product intervention power not just where there is a significant consumer detriment but also where there is potential for such detriment to be borne by vulnerable consumers.

ASIC has been active during the COVID-19 pandemic, surveying different markets (e.g. trading in securities and CFDs) and releasing a number of alerts and guidance for the financial services industry. The changes in the market due to the pandemic have been examined by ASIC and have potentially influenced findings of significant detriment to retail clients. We therefore expect that ASIC will, in making decisions about product intervention orders in the future, continue to scrutinise the effects of COVID-19 on retail clients and their behaviour in relation to financial products as well as that of financial services providers and the performance of relevant products that is or may be causing significant loss to consumers.

[Links to key material: ASIC media release (20-254MR)Consultation Paper 322; ASIC Corporations (Product Intervention Order—Contracts for Differences) Instrument 2020/986; Public notice]