No one said it would be easy. ESMA may have given the EU brokerage community ample time to prepare, but many have termed the recent onslaught of tighter restrictions on binary options and CFDs as “the most ambitious overhaul of Europe’s financial markets in a decade.” The new rules impacting binary options, an outright ban unless you happened to be a “Professional Trader”, went into force in July. CFD restrictions followed in August. Now, amidst the turmoil and confusion, ESMA has extended its so-called temporary rules for three more months, respectively by product, while also advising that it could extend again down the road.
Ostensibly, the ESMA officials may have overreacted, since there has been very little time to assess whether the new regulations have had a real and significant impact. As one reporter recently noted, however, “According to European officials, ESMA and a number of national supervisors have now made it clear in writing that they have observed an increase in the offer of speculative products, including financial contracts for difference (CFDs), binary options and other speculative products (such as rolling spot forex) to retail clients, and at the same time a surge in the numbers of complaints from investors who have suffered significant losses when trading these products”.
The temporary nature of the ESMA intervention measures has also drawn critics, especially from the French chairman of the AMF. France and the Benelux countries were hit particularly harshly by the tens of billions of USD losses that consumer absorbed at the hands of shady binary option operators. When the full breadth of the dark underbelly of that industry became known, French authorities were the most vocal in demanding nations like Cyprus and Israel to clean up their respective acts. Belgium did not wait. It is the one member of the EU that has banned both binary options and CFDs in 2017.
In a speech to the French Senate back in June, Robert Ophèle – Chairman of France’s financial markets authority AMF, spoke glowingly of the ESMA initiatives to curtail losses on high-risk products, but he also expressed concern that the new rules would be implemented in differing ways throughout the EU. A few members might be inclined to ban products altogether, thereby ignoring the temporary nature of the rules. Others could choose to be accommodative, thereby creating a competitive rift in the union that could circumvent the clear intent of the new regulatory regime.
Ophèle went on by citing a local football analogy to drive home his point: “I observe, however, that this approach is far from homogenous in Europe as you have probably noticed yourself thanks to the match Marseille v Madrid. Our Spanish friends tolerate the sponsorship of their teams by financial intermediaries that specialize in toxic products, a practice that we were able to eradicate in France”. Several enterprising brokers have used sport sponsorships in a variety of arenas to get their names before a host of potentially new customers, by leveraging the public’s fascination with celebrities. There have, however, been several instances where fraudsters have used this tactic.
The transition of late has been painful, as was expected. Revenue and volumes are down, even at the larger publicly traded franchises. This type of clampdown necessarily invites a major consolidation of industry players. Larger players will gobble up the “small fish”, i.e., those brokers unable to relocate or without the resources to comply with the new regulations. The better larger firms will also use the new rules to their advantage to move market share in their direction and drive out competition. After a suitable period of time, there will be winners and losers, but the current dynamics will give way to the “fittest” among the brokerage community, in line with natural laws of evolution.
Once that new equilibrium settles in, the consumer will be better served. Choices will be more confined with fewer, but more efficient providers. You will continue to hear loud protestations that offshore brokers are not abiding by the rules, are not applying for necessary domestic or EU licenses, and are continuing to solicit across national borders in clear violation of local statutes. Cross-border fraud will remain a major concern in the EU, in much the same way as it has in the United States after the passage of the Dodd-Frank Act. You can never eliminate fraud. You must contain it within acceptable limits.
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What is a brief summary of the new ESMA regulations?
ESMA took the first half of 2018 to propose new rules regarding binary options and CFDs, solicit feedback from the industry, and then publish final “intervention measures”, as they were called, in June. For binary options, it was simple and straightforward: “Binary Options (from 2 July 2018) – a prohibition on the marketing, distribution or sale of binary options to retail investors.” Officials also noted that ESMA has “the power to introduce temporary intervention measures on a three monthly basis. Before the end of the three months, ESMA will review the product intervention measures and consider the need to extend them for a further three months”.
The group also acknowledged that CFDs were a different story. The press release stated succinctly that, “The new measures on CFDs will, for the first time, ensure that investors cannot lose more money than they put in, restrict the use of leverage and incentives, and provide understandable risk warnings for investors”. The actual details spoke to five specific modifications that were to be implemented by 1 August 2018, and were, as follows:
- Leverage limits on the opening of a position by a retail client from 30:1 to 2:1, which vary according to the volatility of the underlying:
- 30:1 for major currency pairs;
- 20:1 for non-major currency pairs, gold and major indices;
- 10:1 for commodities other than gold and non-major equity indices;
- 5:1 for individual equities and other reference values;
- 2:1 for cryptocurrencies;
- A margin close out rule on a per account basis. This will standardise the percentage of margin (at 50% of minimum required margin) at which providers are required to close out one or more retail client’s open CFDs;
- Negative balance protection on a per account basis. This will provide an overall guaranteed limit on retail client losses;
- A restriction on the incentives offered to trade CFDs; and
- A standardised risk warning, including the percentage of losses on a CFD provider’s retail investor accounts.
ESMA also carved out an “exception” to these rules. If the consumer met their test for being a “Professional Trader”, then the rules would not apply. What were these requirements? In order for a “Candidate” to be treated as a “Professional Trader”, he had to meet two out of three of the following criteria:
- The candidate’s trading volume is of at least 10 deals (each worth at least €150) per quarter, and for the last four quarters;
- The candidate’s financial portfolio, all included, exceeds €500,000;
- The candidate needs to have at least a year of relevant experience in the financial field.
Astute and savvy brokerage houses that have been down the “regulatory clampdown” road on previous occasions were quick to prepare ahead of time. The smarter ones set about toning down their use of binary options, adapting CFD modifications into their marketing materials and software, and testing their client base in order to identify Professional Traders. These brokers were ready when implementation dates came and went, and were properly girded for the competitive battle that would surely come.
What have been the measurable impacts to date?
We are only into October, but a few notable earnings reports from the titans in the CFD industry have already noted that revenues and volumes have been affected and will be impacted going forward. There have been attempts to assess other damage done, but it is far too soon to make any firm determinations. Some reporters went so far as to visit trading rooms on the first few days of August and came back claiming that very little had changed, in stark contrast to the reasons given by ESMA for extending its “intervention measures” for three more months.
If you recall, major brokerage houses shunned binary options in its early days, as nothing more than a “fad”, the primary reason that most brokers for these instruments sprang up in exotic locales across the globe, typically where gambling was the big draw. CFDs, on the other hand, originated in London in 1990 and have been an effective hedging instrument for institutional traders.
The “Big Four” in London are well-respected firms, each offering CFDs and traded on the London Stock Exchange. The brokers are the IG Group, Playtech, Plus500, and CMC Markets, sporting respective market caps of $3.1, $2.0, $1.9, and $0.5 billion. These are not “fly-by-night”, shabby operations. All four firms have professed to lower volumes and revenues in their most recent reports to shareholders, due to new ESMA rules. Plus500 and CMC Markets project shortfalls of 30% and 20%, respectively. The IG Group touts the success of its categorizing 50% its customer base as Professional Traders. IG forecasts a revenue drop of only 10%, the benefit of its more proactive approach to new regulations. Others may soon begin to follow in its footsteps.
As the old adage goes: “Don’t throw out the baby with the bath water.” The forex brokerage industry is fearful that regulators are presently doing just that – throwing out binary options, along with any other OTC online product that appears to involve extreme risk. These temporary rules started out with what appeared to be a balanced approach. Everyone could agree that binary options, defined by many regulators as nothing more than “legalized gambling”, needed a major overhaul, but other instruments, like spot forex and CFDs, have been around in retail trading since the nineties, having evolved from “institutional only” environments to online trading platforms in two decades.
ESMA officials, nor will their national equivalents, curb the desire of their respective citizens to gamble, but they can re-define the nature of the online trading experience going forward. Outright bans will only result in a new innovative product line, perhaps worse than its present progenitor. The majority of new rules directed at CFDs and forex seem, at first glance, to go a long way to crafting a new and safer trading environment, but time is necessary to determine if these new rules need a fine-tuning along the way.
In the meantime, confusion will reign, a fraudster’s paradise, so to speak. It’s time to be patient, cautious, and skeptical, especially of any aggressive marketing come-ons.