The Australian contracts for difference (CFD) market is estimated to be worth up to $400 billion – not bad for a market that did not exist six years ago.
But this very lucrative market is being competed for by providers of two different CFD trading models – the market-maker model, and the direct market access (DMA) model – and the contest is inspiring some underground name-calling between the two kinds of providers.
Under the market-maker model, the CFD provider creates a synthetic market that resembles – but is not – the underlying market. The provider acts as principal: it provides a two-way spread, based on the market price, and the clients trade with it.
The DMA model sees providers quote prices identical to those prevailing in the underlying market. All CFD orders are replicated by the provider placing a corresponding stock order in the underlying market – that is, it hedges client business one-for-one on the Australian Securities Exchange (ASX).
Only market-makers can offer index, currency and commodity CFDs, so the battle is confined to equity CFDs.
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There are more DMA providers than market-makers, although some providers offer both models. Balancing this discrepancy is the fact that market-maker (and founding provider) CMC Markets is the biggest fish in the pool, accounting for up to 60 per cent of local CFD transaction volume.
Talk to DMA providers, and dark tales abound of market-maker clients not having orders filled at the market price, and thus paying more or receiving less; being constantly requoted at the market-maker’s whim; being “stopped out” even though the market price failed to reach their stop-loss price; and trading both with and against their provider – which both takes the other side of a position and sets the price at which it can be traded.
Although the DMA providers all say that they benefit from these purported misgivings – in that clients who are sick of them eventually vote with their feet and leave the market-makers – they can’t seem to stop complaining about them.
Being a market maker, and the biggest CFD provider in the market, CMC Markets is in the firing line. “It can annoy clients that even if the market price doesn’t get to a stop-loss level, CMC’s price might, and they’ll stop the client out,” says Gavin White, head of sales at CFD provider City Index.
“It can also be very difficult as a client when your provider reserves the right to show a price that is not the same as the underlying market – and also reserves the right to show different clients different prices in the same contract at the same time. They know your position. If you’re asking them for a price, they know that you’re about to be a seller or a buyer. They can move their price around accordingly and make small amounts on that,” says White.
David Trew, managing director of CFD issuer CMC Group, says it is a simple situation: “This is a very competitive market, but we still expect to do 60 per cent of the market’s business this year. But we wouldn’t have any customers if we ripped them off.”
DMA providers say that because clients can actually see their trade sitting in the ITS (Integrated Trading System) queue on the ASX, they are guaranteed to have their order executed at the market price.
“But you have to wait to get executed,” counters Trew. “With a market-maker, you’re at the top of the queue all the time.”
Liquidity is another point of contention. DMA providers say that the liquidity they offer is the true liquidity of the ASX. “The customer likes it because the liquidity of the underlying is guaranteed to be there,” says Tony Fay. “If you’re dealing in the underlying market, by definition it is going to be better than the market maker’s spread. It’s a nonsense to say that the market maker will provide better liquidity than the underlying.”
But Trew says exactly that. “We’ve got three streams of liquidity. We’ve got access to all the liquidity in the market, plus all the liquidity of our clients – we can cross positions among them – plus all of our own liquidity.
“We say to clients, ‘you’re going to get the same price as is on the exchange as a minimum, that’s your base line’. But if you’ve got extra volume that you want to do, we can do it for you – even though that liquidity might not be there at the time,” says Trew.
Liquidity is the lifeblood of any market. In October, the ASX entered the CFD market with the quotation of listed CFDs, increasing the competition. While it is early days for the ASX and its stable of providers, liquidity is not great on the ASX and consequently, spreads are wide.
Ultimately, CFD providers seek to differentiate themselves on cost. CFD trading is is a commoditised, price-driven market in which execution prices have reached a level below which most providers do not really want to go. Most providers deal at about 10 basis points, with a funding charge that is typically 2-3 per cent.
In October, CFD provider Marketech threw down the gauntlet to its rivals, with the launch of a zero-brokerage online trading platform. Marketech makes its profit on the overnight financing charge paid by investors with open long (buying) positions to deal.
Other providers – for example IG Markets – look to differentiate themselves by not charging for data prices: most providers charge about $80 a month for live price and volume data.