ESMA to introduce measures to restrict the provision of CFDs, and prohibit the provision of binary options, to retail investors in the EU.
The European Securities and Markets Authority (ESMA) has announced the first use of its new product intervention powers under MiFID II. ESMA had announced before MiFID II came into force that it would introduce such measures, and had launched a brief call for evidence on its specific proposals on 18 January 2018. Despite receiving almost 18,500 responses to the proposals (many of which were presumably objections from the industry), ESMA has pressed ahead regardless, suggesting that the consultation was a mere formality.
The measures will introduce:
- A prohibition on the marketing, distribution, or sale of binary options to retail investors in the EU
- A restriction on the marketing, distribution, or sale of contracts for differences (CFDs) to retail investors in the EU
Specifically, the measures on CFDs will impose leverage limits on the opening of a position by a retail client. The limits will range from 30:1 to 2:1, according to the volatility of the underlying. For example, cryptocurrencies, seen as the most volatile, will be subject to a limit of 2:1, and so CFD providers will have to require retail investors to pay 50% of the notional value of the CFD at opening.
The measures will also include a margin close out rule (on a per account basis), to standardise the percentage of margin at which providers are required to close out a retail client’s open CFDs. CFD providers will have to close open CFD positions on terms most favourable to the client when the sum of funds in the CFD trading account and the unrealised net profits of all open CFDs connected to that account falls to less than half of the total initial margin protection for all of those open CFDs.
Another protection that ESMA is introducing is a negative balance protection to provide an overall guaranteed loss limit. This is to ensure that an investor’s maximum losses from trading CFDs, including all associated costs, are limited to the total funds related to trading CFDs that are in the investor’s CFD trading account.
Finally, the measures will prohibit CFD providers from offering incentives to existing or potential clients in relation to the marketing, distribution, or sale of a CFD, and will require CFD providers to provide retail clients with a standardised risk warning that must set out the percentage of their retail investor CFD trading accounts that lost money over the last 12-month period.
CFDs have been causing regulators concern in various EU Member States in recent years, with some regulators issuing warning statements and imposing their own measures to restrict CFD sales to retail clients. Interesting, MiFID II only permits ESMA to introduce its own intervention measures when a number of criteria are fulfilled, including that EU regulators have not taken action to address the threat to investor protection, or action taken does not adequately address the threat.
ESMA explains that in this situation “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.”
For now, ESMA has explained the measures it is adopting in a press release and accompanying additional information document. The latter provides more detail on the background to and rationale behind the measures. The final measures will be published in the Official Journal in the coming weeks. They will apply to binary options from one month after publication, and to CFDs two months after publication.
ESMA’s temporary product intervention powers only enable ESMA to introduce measures lasting a maximum of three months. ESMA can extend the application of the measures by further three-month increments, but must do so before the end of each three-month period.
The UK Financial Conduct Authority (FCA) also published a statement, commenting on ESMA’s measures. The FCA states that it supports the application of these measures, and expects to consult on whether to apply them on a permanent basis to firms offering CFDs and binary options to retail clients in the UK. The FCA had been planning to make its own rules to tighten up conduct of business requirements for CFD firms, but held off doing so in anticipation of ESMA introducing EU-wide measures.