ESMA opens consultation into new rules for CFD, binary options offering

Maria Nikolova

A leverage cap of 20x is proposed for CFDs on non-major currency pairs, whereas the maximum leverage for CFDs on major currency pairs is set to be 30x.

In line with an earlier announcement, the European Securities and Markets Authority (ESMA) has just opened a consultation on proposed new rules for CFD and binary options offering. The new regulations are set to provide extra protection to retail investors.

In relation to CFDs, ESMA is considering restricting the marketing, distribution or sale to retail clients of CFDs, including rolling spot forex.

ESMA has analysed various options. For example, ESMA considered whether to prohibit the marketing, distribution or sale of CFDs. While this option would have been expected to minimise consumer detriment, ESMA currently believes the objective of investor protection can be adequately achieved by restrictions on the provision of CFDs to retail clients, rather than a prohibition.

The regulator notes that, in each case, the restrictions contemplated would only apply in respect of retail clients. The option of applying the restrictions to professional clients is not under consideration due to the lack of evidence of harm to this type of client.

i. Leverage limits on the opening of a position by a retail client. The contemplated leverage limits would apply to any payment made to a product provider for the purpose of entering into a CFD, excluding commission and transaction fees. They would range from 30:1 to 5:1 to reflect the historical price behaviour of different classes of underlying assets. In particular:

  • for CFDs in major currency pairs, which have relatively low historical volatility, a limit of 30:1 is being considered;
  • for CFDs in non-major currency pairs and major equity indices, a limit of 20:1 is being considered;
  • for CFDs in gold, a relatively stable commodity, a limit of 20:1 is being considered;
  • for CFDs in commodities other than gold, and for CFDs in minor equity indices, a limit of 10:1 is being considered; and
  • for individual equities, which tend to be relatively volatile, and for any underlying not otherwise listed above, a limit of 5:1 is being considered.

ESMA is also considering how CFDs on cryptocurrencies fit within the MiFID regulatory framework as financial instruments. ESMA welcomes views on the matter. In this context ESMA is currently discussing whether CFDs on cryptocurrencies, whose underlying assets have displayed very high price variation, should be addressed in the measures and whether a 5:1 initial leverage would provide investors with sufficient protection. Alternatively, a lower leverage limit (2:1 or 1:1) or stricter measures (such as a prohibition on the marketing, distribution or sale of CFDs in cryptocurrencies to retail clients) could be considered.

A margin close-out rule on a position-by-position basis. This measures aims to standardise the percentage of margin at which providers are required to close out a retail client’s open CFD. The goal is that, consistently across providers, clients are routinely protected from losing more than what they have invested.

Negative balance protection on a per-account basis, to provide an overall guaranteed limit on retail client losses. ESMA has discussed whether such a limit should apply on a “per position” or a “per account” basis. Implementing this rule on a “per position” basis would ensure a stronger protection to clients but it would likely increase the impact on firms and therefore on the ongoing prices offered to clients.

A restriction on incentivisation of trading provided directly or indirectly by a CFD provider, such as providing retail clients with a payment (other than a realised profit on any CFD provided) or a non-monetary benefit in relation to the marketing, sale or distribution of a CFD. This measure aims to minimize the risk that such incentives are used to entice retail clients to these often unsuitable as well as complex products.

A standardised risk warning. ESMA is considering requiring CFD providers to provide a standardised warning in any communication to, or published information accessible by, a retail client relating to the marketing, distribution or sale of a CFD. At present, ESMA’s preferred option is that this standardised warning would indicate the percentage range of retail investor accounts having losses. ESMA is also considering to require a more abbreviated version of the risk warning when the relevant communication or published information to a retail client is made other than through a durable medium or a webpage.

An alternative proposal is to require firms to disclose the percentage of client accounts that were loss-making and profit-making based on each firm’s client data from previous quarters.

In relation to binary options, the regulator is considering a prohibition on the marketing, distribution or sale of binary options to retail clients. ESMA is currently minded to adopt this measure as the significant investor protection concerns relating to this product are due to inherent features of the product that are unlikely to be sufficiently addressed through certain restrictions on the product (such as minimum duration contract periods). In particular, the pricing structure of the product means that, on average, investors will experience negative expected returns without providing any clear compensating benefits to retail investors (e.g. the hedging function served by vanilla options). The alternative option of a total ban that would include professional clients is not under consideration due to the lack of evidence of harm to this type of client.

The consultation closes on February 5, 2018.

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