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Proposal to Declare Certain Derivative Contracts to be Futures Contracts Under the Securities Markets Act 1988

A Discussion Paper

5. CFDs - PROPOSED DECLARATION

5.1

A CFD is a derivative contract in which an investor can receive the economic benefits of holding an underlying commodity or instrument without having equitable or legal title to that commodity or instrument. The price of the CFD is derived from the underlying commodity or instrument and the counterparties to the CFD agree to settle the difference between the acquisition and disposal price in cash. Therefore, there is no delivery of the underlying commodity or instrument. The past two years have seen an interesting use of CFDs in the Australian and New Zealand markets.

5.2

An essential element of a futures contract for the purposes of the Securities Markets Act is that the contract must relate to a "commodity". Commodity is defined in that Act as "any type of goods; and includes foreign currency and a financial instrument". The Securities Markets Act does not define the term "goods".

5.3

CFDs in respect of most commodities are clearly understood by industry participants to be futures contracts, for example CFDs in respect of:

• foreign currencies;
• stock indices; or
• gold and silver.

5.4

However, there is an ongoing uncertainty as to whether or not equity securities are "goods" in terms of the definition of "commodity", which in turn affects whether or not a contract for future delivery of shares or other equity products (which can be settled otherwise than by delivery) is one for delivery of a "commodity" under the Securities Markets Act. For this reason the Commission has made several declarations for individual equity derivative products, including some equity CFDs. We refer to:

• the Futures Contracts (Man Financial Australia Limited Agreements) Notice 2006;
• the Futures Contracts (CMC Markets NZ Limited Agreements) Notice 2006;
• the Futures Contracts (NZFOX Share Options) Notice 2005;
• the Futures Contracts (ABN AMRO Australia Limited Options) Notice 2004;
• the Futures Contracts (Macquarie Bank Limited Options) Notice 2003;
• the Futures Contracts (Options for Quoted Securities) Notice 1992;
• the Futures Contracts (Options for Quoted Securities) Notice 1990.

5.5

The proposed declaration will supersede any current declarations in respect of individual equity CFDs.

5.6

It is desirable for there to be certainty in the market concerning the scope and effect of regulation. Given the synthetic nature of CFDs in respect of shares or other securities, and given the fact that CFDs in respect of other commodities are regulated as futures contracts, we believe it would be more desirable to regulate them as derivative products, under the laws relating to futures dealing, rather than under the Securities Act regime. In particular, this approach has the advantage of providing certainty for the issuer regarding compliance with both the securities and the futures dealing regimes.

5.7

The Commission recognises that CFDs are often created and marketed by a financial institution as a specific product issued by that institution. In these circumstances the Commission has to date made terms of authorisation for dealers (issuers) of these products largely dependent on appropriate product disclosure, recognising that the issuing company is not undertaking an intermediary role. We expect to continue this approach. An example of typical terms of authorisation can be seen in the Authorised Futures Dealers Notice (No. 4) 2006, which requires the CFDs to be marketed in a product disclosure document complying with Australian law.

5.8

We believe the Commission's proposal to use its declaration power to declare that CFDs in respect of shares or other securities are futures contracts for the purposes of the Securities Markets Act would be consistent with the policy of that Act.