Europe-wide Ban on ‘risky’ Binary Options and New Requirements on Contracts for Difference introduced by ESMA
On 27 March 2018, the European Securities and Markets Authority (ESMA) announced a ban on the marketing, distribution and sale of binary options to retail investors. ESMA also announced that it will require a mandatory risk warning for all Contracts for Difference (CFDs) sold to retail investors. This represents the first use of ESMA’s product banning powers under article 40 of the Markets in Financial Instruments Regulation.
ESMA said that it was concerned with how these inherently high-risk speculative products are offered to retail investors. Binary options allow an investor to ‘win’ a lump sum of cash if the value of an agreed underlying asset is above a certain price when the option expires. CFDs allow an investor to bet on the underlying price movement of an asset without actually having to own it. Because they are leveraged contracts, the amount the investor may lose if the asset value goes against the bet is of a much greater magnitude.
“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”, ESMA said.
BAN ON BINARY OPTIONS
The ban on binary options will last for 3 months and is expected to come into force in Summer 2018. The Financial Conduct Authority (FCA), which will enforce the ban for UK investors, welcomed the EU-wide temporary product intervention measures and plans to consult on whether these measures should be put in place on a permanent basis. The ban on marketing binary options will extend to social media as well as the use of sport sponsorship.
The measures announced by ESMA will only apply to retail clients. Binary options may still be marketed, distributed and sold to so-called professional clients, including those clients who elect to be classified as professional. In its Frequently Asked Questions, ESMA has warned retail investors to consider very carefully whether they should adopt professional client status and lose the extra regulatory protections afforded to retail clients.
Concerns remain about non EU-based binary options firms offering binary options to European retail investors. In the minutes of ESMA’s Securities and Markets Stakeholder Group meeting on 8 February 2018, the ESMA Chairman Steven Maijoor noted that ESMA would also be able to address offers coming from outside the EU by use of the product intervention powers.
MANDATORY REQUIREMENTS ON CFDS
ESMA’s use of its product intervention powers for CFDs consist of mandated:
- Leverage limits on the opening of a position by a retail client from 30:1 to 2:1;
- A margin close-out rule of 50% on a per account basis;
- Negative balance protection on a per account basis;
- A restriction on the incentives offered to trade CFDs; and
- A standardised risk warning, including the percentage of losses on a CFD provider’s retail investor accounts.
This mandatory warning and percentage figures of investor losses are expected to boost transparency in the CFD industry and give retail investors pause before investing in CFDs.
IG Group Holdings Plc (IG), an operator of an online trading platform offering CFDs, stated that it was 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”.
IG also noted that the ESMA announcement relates only to retail clients. IG’s client base is predominantly sophisticated traders. IG believes that clients categorised as elective professional generate over half its UK and EU revenue. The measures imposed by ESMA will not apply to these professional clients.