When selecting a CFD provider, it's important to research the policies followed by the company concerning the use of client money. Our beginner's guide has everything you need to know about client money protection, allowing you to stay informed and choose the best CFD provider for you.
Counterparty Risk
If you are involved in a transaction, the ‘counterparty’ is the person or company on the other side of that transaction. When trading CFDs, as you are buying or selling the CFD from the CFD provider, the CFD provider is the counterparty.
Counterparty risk is the risk that the counterparty does not fulfil their obligations.
Because IG Markets hedges client positions with its own money and keeps all client funds (including net running profits) in a separate trust account, the counterparty risk when trading with IG Markets is lower than it might be when trading with other CFD providers who don’t follow the same standards.
Hedging Client Positions
When you open a CFD position, CFD providers may hedge that position in the underlying market.
If you bought 1,000 Westpac share CFDs, for example, as the CFD provider sold the CFDs to you, it would have a corresponding short CFD position. If the price of Westpac shares went up, you would make a profit while your provider would make a loss. To reduce this risk, some CFD providers may hedge client positions in the underlying market. In this case, if the provider did hedge, it would buy 1,000 Westpac shares.
Now the CFD provider would hold two positions – a short position on 1,000 share CFDs, and a long position on 1,000 shares. If the share price rose, the provider would make a loss on the short position, but this would be offset by a profit on the long position. Likewise, if the share price fell, the provider would make a loss on the long position which would be offset by a profit on the short position.
Your CFD position remains unchanged – when the price of Westpac goes up, you make a profit, and when it falls you make a loss.
The Industry Standard
Most CFD providers fall into either the Market Maker or Direct Market Access (DMA) category. While DMA providers hedge client positions in the underlying market, Market Makers may or may not hedge these positions.
Consequently, not all CFD providers will hedge client positions in the underlying market.
Those that do, often use client funds to take corresponding positions with brokers. This exposes clients to the risk that either the CFD provider or the provider’s broker will default, and the clients will lose their money.
IG Markets’ Standard
IG Markets acts as the counterparty to all CFD trades and aims to internally match client buy and sell trades. However IG Markets will frequently participate in the underlying market to hedge client positions. Clients that opt to use IG Markets’ DMA platform for share CFD trading will have all their orders matched in the underlying market. There is no extra charge for this service and the prices offered on each method of trading are the same.
IG Markets also keeps all client funds in a separate, regulated trust account. Consequently, it only uses its own funds to hedge, and would have used its own funds to buy the 1,000 Westpac shares in the example above.
Holding Client Funds
In Australia, CFD providers are obligated to separate client funds from their own funds in accordance with Australian Client Money Rules. This does not include any client money that the CFD provider might use for hedging and can subsequently be withdrawn from the client money account.
The Industry Standard
All CFD providers regulated by ASIC must keep client funds in a separate account. However, this regulation only covers client deposits.
Let’s say you opened your CFD account with a deposit of $10,000 and, after a few weeks, you accumulated a running, unrealised profit of $1,800. A CFD provider is under no obligation to store that $1,800 in a separate account designated for client funds and could instead pool that running profit with its own funds.
IG Markets’ Standard
IG Markets holds all client funds in a regulated trust account at a top-tier Australian bank. This means that client money is not pooled with IG Markets’ money.
Additionally, IG Markets also keeps your net running, unrealised profits in a regulated trust account. Consequently, IG Markets does not use your deposits or your unrealised profits to hedge in the underlying market.
This exceeds both contractual and regulatory obligations.
Business Models
Different CFD providers may have different profit structures in their business models.
The Industry Standard
Some CFD providers’ profits are dependent on their clients making a loss. This generally occurs when CFD providers don’t hedge their clients’ positions.
In the example involving Westpac share CFDs, if the CFD position was unhedged, you would have held a long position while the provider would have held a short position. Consequently, your profit would have resulted in the CFD provider making a loss, and your loss would have resulted in a profit for the CFD provider.
IG Markets’ Standard
As IG Markets hedges client positions either internally or in the underlying markets, its profits are not dependent on client losses.
Instead, IG Markets makes its profits in commissions or trading spreads, and overnight financing charges.
Commissions are charged when a position on a share CFD is opened and closed, and these commissions start from 0.1% of the value of the position, with a minimum charge of $8. If you opened a position on 250 shares valued at $50 a share, the total value of your position would be $12,500 (though because CFDs are a geared product you could open this position with a margin from just 5%, rather than paying the full $12,500). The commission for opening this position would be $12.50 ($12,500 x 0.1%). If the value of the share rose to $52, bringing the total value of the position to $13,000, and you decided to close the position, your closing commission would be $13 ($13,000 x 0.1%).
On other markets, like forex, stock indices, commodities and options, IG Markets charges a trading spread. Spreads vary depending on the market you trade, with spreads on forex pairs starting at 0.8 pips and spreads on stock indices starting at less than 1 point. Please see the Contract Details for each of these markets for more information.
Overnight financing charges are interest charges debited from your account for every day you keep a long position open. If you hold a short position, you may be credited interest.
Regulation
IG Markets is regulated by ASIC and is a holder of Australian Financial Services Licence 220440. IG Group companies are regulated by the local regulators in each country of operation.
As the longest established CFD provider in Australia and one of the longest established globally, IG Markets’ staff typically have a wealth of experience in the industry, and are trained to exacting standards on an ongoing basis.
Being a Smart Consumer
Choosing the right CFD provider is the first step in managing your trading risk.
All traders are advised to look for information in a CFD provider’s Product Disclosure Statement (PDS) for information about how the provider hedges client positions and stores client funds. Calling client services for information and looking into financial statements (if available) can also be beneficial.