Europe’s regulator ESMA makes continental clampdown on binary options and CFDs

Following the individual regulators within European nations including France, Holland, Belgium, Denmark and Germany recently having taken steps toward banishing the advertising and soliciting of binary options products and in some cases outlawing all OTC products made available on electronic retail trading platforms altogether, the European continental regulator, ESMA, has now made its case clear, citing CFDs and binary options as a matter for great concern.

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 proliferation of these types of products gives rise to investor protection concerns. These products are inherently risky, complex and speculative. Supervisors have also observed that
they are often marketed and sold in an aggressive way and that some firms fail to comply with their regulatory obligations under MiFID, creating the conditions for retail investors to suffer
significant detriment, e.g. in the form of unexpected losses.

ESMA considers these products to carry a very high level of risk. They are not standardised and the specific features of the products can be different from one provider to another, including for example in relation to the terms, conditions and costs involved. ESMA’s warnings state that studies performed by some national supervisors show that in most cases, retail clients speculating in CFDs, binary options or other speculative products lose the money they have invested.

However, notwithstanding these features, in many cases, these products are widely advertised to the retail mass market across the European Union, often via online platforms. Furthermore, it has been observed by ESMA that these products are also being offered by unauthorised and unregulated entities which further adds to the risk of investor detriment.

The provision of these types of speculative products to retail clients is a topic that ESMA has been monitoring for some time. ESMA’s investor warning on CFDs, published in February
2013, highlights some of the main risks of investing in CFDs and urges investors to check if their provider is authorised to do investment business in their country.

It also describes some poor practices that have been observed in this sector of the market. ESMA observed that potential gains may be advertised in a way that is designed to encourage retail investors to trade and emphasises the possible gains without fully explaining, or giving sufficient prominence to the risks involved and the potential for losses. The retail investor might conclude that there is little or no risk involved when investing in speculative products. This, according to ESMA, is wrong.

Providers of CFDs, binary options and other speculative products may also offer “free start-up money”, gifts, discounted fees, or trading tutorials in order to attract retail investors as new
clients.

Generally, the buying and selling of these speculative products, especially when done online, is not accompanied by investment advice. ESMA states that this means that an assessment of suitability of the product for clients does not take place. Nevertheless, an authorised and regulated firm must first check that dealing in speculative products is appropriate for the retail investor and that
he/she is aware of the risks involved.

In the cases mentioned here, many of the risks for retail clients are caused by the business models adopted by firms in this sector, which may create conflicts between the commercial
interests of the firm and the interests of the retail client. For example, if the remuneration of staff or affiliates is linked solely to the numbers of new clients signed up, or if the profit of the firm is directly linked to the loss of the retail client, a clear conflict of interest exists that should be avoided.

In February 2014, ESMA also issued an opinion on MiFID practices for firms selling complex products and an accompanying investor warning on the risks of investing in complex products.

ESMA’s recent focus has been on promoting common supervisory approaches and practices across Europe in relation to the provision of CFDs, binary options and other speculative products to retail clients, as this is an area in which many competent authorities have serious concerns about the protection of investors and where there is a considerable degree of crossborder
activity.

In April, June and July 2016, ESMA published questions and answers (Q&As) on the provision of CFDs and other speculative products to retail clients. The purpose of these Q&As is to enhance supervisory convergence in the application of MiFID I and its implementing measures on key topics that are relevant when such speculative products are sold to retail investors.