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European regulators get tough on CFDs and Binary Options – Now what?

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It may have taken tens of billions in Dollars and Euros of consumer losses and persistent outcries from the public at large, but European regulatory officials finally stepped up to the bar and got tough on both CFDs and Binary Options. Studies had already shown that, across different EU jurisdictions, “74-89% of retail accounts usually lose money on their investments, with average losses per client ranging from €1,600 to €29,000.” Analyses also confirmed that losses on binary options were consistent with CFD experiences on retail clients’ accounts.

The European Securities Markets Authority (“ESMA”) had deliberated for months before its Chairman made the following statement: “The agreed measures ESMA is announcing today will guarantee greater investor protection across the EU by ensuring a common minimum level of protection for retail investors. 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 risk warning for investors. For binary options, the prohibition we are announcing is needed to protect investors due to the products’ characteristics.”

ESMA

Agreement, however, is not the same as implementation. It could be a few months before new rules go into effect, which include an outright ban on binary options for retail investors to restrictions on leverage and related marketing of CFDs (“Contract for Difference”). Brokers have objected to many of the new provisions, proclaiming that leverage restrictions are “draconian’ and will encourage clients to shop overseas for a broker, which will more than likely be un- or under regulated, at best. These same cries of foul were heard in the U.S. in late 2010 when the CFTC introduced its tougher stance on leverage, but those rules applied to retail forex trading in general.

How bad are the leverage restrictions on CFDs? One summary states: “The leverage restrictions for retail clients will be introduced in several tiers. CFDs on major FX pairs will be traded with 30:1, indices, non-major currency pairs and gold will be traded at 20:1, while other commodities and non-major indices will be provided with a 10:1 gearing. Brokers will be able to offer individual equities at a 5:1 leverage and crypto-currencies at 2:1.” There must also be “no-negative balance” guarantees that will, by their nature, require more capital on behalf of the broker to comply. The real loser in these dealings seem to be crypto-currencies, which tend to experience exaggerated volatility while still in their infant stage of development.

How have the industry giants responded to these restrictive actions?

Something had to be done to raise the confidence of traders in their respective brokers and regulatory institutions. Losses and complaints have gotten way out of hand, and it appeared that very little was going to be done about the problem. Cross-border lawsuits can take decades to roll through the global legal system, often ending in very little in the way of resolution or recovery of losses. A few fines may be issued to foreign citizens that have long departed the scene, fines that will never be paid in the long run. Regulators are generally loath to protect consumers from their own bad habits, if the cases are few and isolated, but scams and shady business practices have been rampant in the CFD and binary option markets for quite a few years.

Industry giants like the IG Group, CMC Markets, and Plus500, all publicly traded on the London stock exchange, were quick to respond in the press about these new rules. The pattern here is also quite familiar. Both entities agree that the ESMA measures will be good for the industry and help end bad business behaviors that were obviously prevalent among their competitors. After self-serving declarations like these, the real truth comes out. They fear future revenue streams will be impaired, as clients take their capital and move it to more risky locales, where leverage restrictions do not exist and regulatory oversight is scant at best.

The statement published by the IG Group left no doubt about their true objections: “We are disappointed that ESMA has chosen to proceed with its proposal to impose disproportionate leverage restrictions which will unduly restrict consumer choice, and risk pushing retail clients to providers based outside of the EU or to use other products which allow the leverage clients seek. This may result in poor client outcomes.”

The comments from Plus500 were also par for the course: “As previously stated, Plus500 has welcomed and is already aligned with many of the changes proposed by regulators, which the Board believes will enhance the CFD trading landscape. Given the very strong start to 2018 trading, the Board believes there will be a limited impact on 2018’s expected financial performance. The Board will assess the potential impact on future years, but believes that Plus500’s highly flexible business model and global diversification with seven licenses in different jurisdictions, five of which are outside Europe, provide confidence in the Company’s future prospects.”

Therein lies the solution – establish trading subsidiaries in foreign jurisdictions that will attract your recalcitrant crew of clients that want to trade on the “bleeding edge”, so to speak. Forex brokers, especially ones that focused on CFDs and binary options, have been building this kind of infrastructure for the past decade, as if anticipating the changes to come. The issue, however, for publicly traded companies is to find a legal way to achieve this objective that will not blow up as a public relations debacle down the road. The FXCM story is still on everyone’s lips in that regard.

The other “loophole” in the law will be to find a way to easily classify a retail trader as a “professional” trader under the new rules and thereby become exempt. We suspect that this definition will be stretched to the limit and will also become a major news headline in the future when a regulator reacts negatively. Both IG and CMC Markets have stated that they intend to target “elective professionals”, but despite these entreaties, the share prices for both firms took a dive of five percent. In what has been labeled a “bizarre twist”, Plus500 shares actually rebounded five percent.

What have spokespersons for CFDs and binary options been saying?

In anticipation of the onslaught to come, brokers heavily tied to CFDs and binary option trading formed an industry trade group, the CFD and FX Association, to produce positive spin on its behalf. The group was quick to pounce on a study released by ESMA a few days back that actually revealed: “From more than 4,000 complaints related to financial services products, only about 400 were related to forex and CFDs brokers. The paper includes complaints that have been filed with national competent authorities during the first half of 2017. The figure represents only about 10 percent of the total, a continued drop in the figure for the third year in a row.”

2015 was the year of the Swiss Franc Debacle, an event that the Swiss National Bank would like to disappear from the public consciousness, but its ramifications are still being felt today. If you discount the fact that 2015 was unusual, then the trade group can paint a tidier picture: “Complaints relating to CFDs are low and falling consistently due to effective regulation and due to our members focusing on client protection. There has been real progress by our member firms towards improving service levels, protection, and client outcomes.”

The group had more to say, as well: “Client satisfaction rates amongst our membership are high, and the ESMA report underlines the need to view CFDs within the context of retail product complaints more broadly. CFD complaints are very low when you consider that tens of thousands of people trade CFDs every day, and our members alone execute over 200 million CFD trades for clients each year.” These carefully crafted statements, however, fell upon deaf ears at ESMA. They countered these arguments with the news of new measures before a week had passed. So much for the value of “spin doctors”!

How will these impacted brokers deal with their new reality?

There may only be a two to three month breathing period before restrictions become the law of the land. The FCA has already stated that it will follow the lead of ESMA in every aspect. One informed source believes the actions will necessitate the following actions by impacted brokers:

  • Ads – First, brokers must rethink or revise their online strategies for companies like Google, Facebook, and Twitter. Of course, halting ads is never ideal, however playing by the rules is necessary to avoid fines, account bans or worse.
  • Risk Warnings – Brokers must have a standard risk warning in place. Today, they do this, but the new regulations require them to include the actual percentage of losses that a customer can incur per trade.
  • Website – Brokers must start auditing their websites and removing the soon-to-be banned content. This needs to happen on websites, eBooks, videos and partner sites.
  • Inform Clients – Some will be heartbroken, but it must be done. Informing traders of the new leverage rules is necessary. It will also prevent traders from thinking they can shop around for a better leverage deal. They can’t.”

We need not shed any tears for our brokers. They have seen this coming for months. Many have already been tackling the subsidiary-in-a-foreign-jurisdiction route or persuading their better set of retail clients to take on the “Professional” title. Benefits may be less, but we suspect that creativity will prevail to reverse that current situation. The next few months should prove to be interesting.

Concluding Remarks

ESMA officials have finally spoken, and it is now time for the real scrambling to occur. Market share is up for grabs in the CFD and binary options space. Cross-border solicitations, forbidden by most every regulator in a developed country, will more than likely step up their pace, legal or not. Similar legislation in the United States culminated in a total reshaping of the forex industry and its major players, but the entire forex marketplace was up for grabs in that case.

In some respects, the stakes are smaller, but highly lucrative, just the same. A casualty rate approaching 90% is not to be ignored, especially by the shadiest operators that have learned to prosper in a virtual environment, where a “Wild, Wild, West” attitude prevails. Have regulators shot themselves in both feet, or have they done what is really best for the consumer, brokers, and for their tarnished image?

Whatever the final outcome, one thing is certain — the times, they are a-changing!

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