The European Securities and Market Authority issues a statement on preparatory work on retail CFD’s, Binary Options and other trading products
Late on Friday, the ESMA slipped out an update on work related to retail trading products. It’s part of a global and industry wide look at how retail products are offered & marketed, and whether the risks involved are to large for retail investors. The statement has caught a few retail entities on the hop as the ESMA state that they may use their “intervention powers” to address any issues. Three of the main areas of concern are binary options, leverage levels offered to retail investors and the methods of enticing business via incentives. They also wish to look at negative balance coverage to provide limits on loses.
Due to the statement being released after market hours on Friday, stock prices of some retail brokers suffered today as firms played catch up with the the news. Plus500 and CMC Markets were down 10-20%. today. Some brokers are already pushing back on the ESMA’s view of implementing leverage caps of 30:1 (on Forex trading) and 5:1 on higher-risk trading. IG said that those caps were “disproportionate”, and that it could drive traders offshore and into less well regulated brokers. Gain Capital warned of “‘unintended consequences’ from the proposed leverage caps.
Here’s the ESMA statement in full;
Statement on preparatory work of the European Securities and Markets Authority in relation to CFDs and binary options offered to retail clients
The European Securities and Markets Authority (ESMA) is issuing this statement to provide an update on its work in relation to the provision of contracts for differences (CFDs), including rolling spot forex, and binary options to retail clients.
ESMA has been concerned about the provision of speculative products such as CFDs, including rolling spot forex, and binary options to retail clients for a considerable period of time and has conducted ongoing monitoring and supervisory convergence work in this area. Some competent authorities have also adopted national measures to limit the provision of these products to retail clients.
Notwithstanding these actions, ESMA remains concerned that the risks to investor protection are not sufficiently controlled or reduced. Further to the ESMA statement published in June 2017, ESMA is considering the possible use of its product intervention powers under Article 40 of MiFIR to address these investor protection risks. In particular, ESMA is considering measures to:
- Prohibit the marketing, distribution or sale to retail clients of binary options; and
- Restrict the marketing, distribution or sale to retail clients of CFDs, including rolling spot forex.
The restrictions on CFDs currently under review are:
- Leverage limits on the opening of a position between 30:1 and 5:1, whose limit will vary according to the volatility of the underlying asset;
- A margin close-out rule;
- Negative balance protection to provide a guaranteed limit on client losses;
- A restriction on benefits incentivising trading; and
- A standardised risk warning.
ESMA will conduct a brief public consultation in January 2018 on this matter.
Any product intervention measure adopted by ESMA under Article 40 of MiFIR can have an initial duration of up to three months and is renewable.
 ESMA35-36-885 Statement on preparatory work of the European Securities and Markets Authority in relation to CFDs, binary options and other speculative products published 29 June 2017 (https://www.esma.europa.eu/document/product-intervention-general-statement).
 Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012, OJ L 173, 12.6.2014, p. 84–148.
Taking one subject, like leverage, the problems arise because many traders do not know how to use leverage properly and to their advantage. Leverage should never be used to allow traders to trade with exponentially higher volumes than their original deposits. It’s like the old saying, “if you haven’t got it, you shouldn’t spend it”. Leverage can be used as a good money management tool. For example, I keep the majority of my trading funds in my bank and only deposit the minimum necessary to trade. I then use the offered leverage to scale up to what is sitting in my bank account, and just transfer back and forth when margins/profits/losses require. That means the bulk of my trading capital is sitting in my own account and not a brokers, and I’m basically using their money to trade.
There’s no doubt that restrictions will be coming but because of this simple lack of understanding and education, they will move regulations from one extreme to another, instead of working to find an appropriate balance.
Regulators are still at a very early stage of this consultation and they will still be gauging public opinion, so if you have a view, get on to them and give it.