ESMA Bans Binary Options and Restricts CFDs to Protect Interest of Retail Investors - The Industry Spread

Karthik Subramanian

Karthik Subramanian has been a professional trader and fund manager over the last 18 years. He is basically a software developer who made the transition to financial domain around 18 years back as the attractiveness of the financial markets proved too much for him. He lives in Chennai in India along with his wife and son. He began his career as a software developer in 1999 and then gradually moved into the financial industry as he began trading stocks in his pastime. He then moved into the financial markets full time and then shifted his focus to the FX markets due to the liquid nature of these markets. Since then, he has been trading FX diligently and his favourite pair are the EURUSD and EURJPY. Over the last couple of years, he has found blockchain to be of high interest and considering his background in software and finance, he has since assembled a team of highly talented developers who have since worked on a variety of projects like crypto exchanges and blockchain architecturing. Now, he balances his time between trading and commenting on both the FX and crypto markets. He has worked with many publications including FX Street and Finance Magnates, which has helped him gain experience and also recognition across the industry. He loves to write and this passion has helped him to reach out across the FX and crypto industry. Right now, he works on his pet projects in the FX and crypto industry and spends his time writing and managing his blockchain team and helping it to reach higher.

ESMA Bans Binary Options and Restricts CFDs to Protect Interest of Retail Investors

March 27, 2018

European Securities Market AuthorityThe European Securities Market Authority (ESMA) today came out with its final proposals to govern the leveraged trading segment. The final proposal remains unchanged from its original version despite having tons of feedback from clients and brokers during its consultation period. The regulator has agreed on measures on the provisions of the contract of differences (CFDs) and binary options to retail investors in the European Union.

The new measures will be published in coming weeks in the official journal of the EU and will be applied to binary options after one month and two months for CFDs after their publication in the official journal.

The new measures include:

For Binary Option: The regulator has banned marketing, distribution and sale of binary options to retail investors.

For Contract of Differences (CFDs): The regulator has restricted the marketing and distribution of CFDs to retail investors. The restriction includes:

  • Leverage limits on opening positions
  • Margin closeout rule on a per account basis
  • Negative balance protection on a per account basis preventing the use of incentives by a CFD provider
  • Firm-specific risk warning delivered in a standardised way

The ESMA, along with National Competent Authorities (NCA) concluded the requirement of significant measure for investor protection in CFDs and binary options offered to retail investors because of lack of transparency and the particular feature of CFDs that include excessive leverage and binary options. The regulator has introduced several tiers of leverage restriction under Article 40 of the Markets in Financial Instruments Regulation.The leverage limits on the opening of a position by a retail client follows:

  • 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

Other measures include for brokers includes providing negative balance protection and close out margin positions whenever the account reached 50 percent of the minimum required margin. Restriction on incentives offered to trade on CFDs and creating a standardised risk warning system that displays the percentage of clients losses.

As expected brokers will also need to provide negative balance protection and close out margin positions whenever the account reaches 50 percent of the minimum required margin. Bonuses and any form of incentives are also prohibited, while brokers also need to develop a standardized risk warning which displays what percentage of clients loses money.

The measures were agreed on by ESMA’s Board of Supervisor on March 23rd, 2018. The chair of the Board, Steven Maijoor, said:

“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.

“The combination of the promise of high returns, easy-to-trade digital platforms, in an environment of historical low interest rates has created an offer that appeals to retail investors. However, the inherent complexity of the products and their excessive leverage – in the case of CFDs – has resulted in significant losses for retail investors.

“A pan-EU approach is required given the cross-border nature of these products,  and ESMA’s intervention is the most appropriate and efficient tool to address this major investor protection issue.”

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