The European Securities and Markets Authority (ESMA) has agreed a range of product intervention measures that will be applied to the provision of contracts for difference (CFDs), including rolling spot forex and financial spread bets, and binary options to retail clients. The reason for this decision is the significant protection concern in the offer of CFDs and binary options to retail investors. This is due to their complexity and lack of transparency, to the disparity between the expected return and the risk of loss, and to the conflict of interest issues related to their marketing and distribution.
Following a very short consultation, for which almost 18,500 responses were received, ESMA has agreed the following:
- Prohibition on the marketing, distribution, or sale of binary options to retail clients; and
- Restrictions on the marketing, distribution, or sale to retail clients of CFDs, including rolling spot forex and financial spread bets.
The restrictions applied to CFDs are:
- Leverage limits on the opening of a position between 30:1 and 2:1, depending on the price volatility of the underlying asset;
- 50% margin close out rule applied on a per account basis;
- Negative balance protection, limiting retail clients’ liability to the funds in their CFD trading account;
- The prohibition on firms offering monetary and non-monetary benefits (excluding research and information tools) to retail investors; and
- A standardised risk warning, including firm-specific figures on the percentage of client accounts that have lost money trading CFDs.
These restrictions have a legal basis in Article 40 of the Markets in Financial Instruments Regulation (MiFIR) and will have an initial duration of up to three months, after which ESMA will consider the need to extend the intervention measures for a further three months.
The Financial Conduct Authority (FCA) stated that they support ESMA’s application of these product intervention measures and that expects to consult on whether to apply these measures on a permanent basis to firms offering CFDs and binary options to retail clients. ESMA will publish an official notice on its website in the coming weeks. Firms will be required to implement the prohibition on binary options one month after the publication of these measures on the Official Journal of the EU (OJ). ESMA has allowed more time for compliance with the CFD restrictions, which must be implemented two months after the OJ publication.
This decision is not completely unexpected but still is a turmoil for its implications. First on retail firms and on their business model. IFPRU 125K firms (trading as matched principal) will need to assess whether they can afford offering a negative balance protection in light of their limitation on taking on market risks. These changes may have implications for future revenue projections and result in the revision of capital and liquidity requirements. Many of these firms will need to apply for a variation of permission (VoP) to keep offering CFDs to retail clients. There will be a strong impact also on investors who, contrary to ESMA’s intention to protect them, might be driven to trade CFDs with unregulated offshore brokers in order to maintain the current trading style and be able to bypass the restrictions on leverage. Some traders might decide to request a different categorisation as “elective professional”, but what about smaller traders?
It will be interesting to see what will happen at the end of the first three months and whether some of these measures will be proved right for investors and for the industry.