On 1 June 2018, the European Securities and Markets Authority (ESMA) formally adopted new measures to prohibit the sale of binary options and to place restrictions on the provision of contracts for difference (CFDs) to retail investors. The measures will apply to binary options from 2 July 2018 and CFDs from 1 August 2018.
As we have previously reported, these steps have been taken as a result of mounting concern over the past few years by ESMA and national regulators, including the Financial Conduct Authority, regarding the risks that binary options and CFDs pose to retail investors.
In summary, ESMA has concluded that binary options are inherently risky and complex products that do not meet any genuine investment need of retail investors and can result in extensive losses, which has resulted in its decision to prohibit their sale to retail customers altogether.
Whereas, ESMA does consider CFDs meet a genuine investment need, so has instead sought to restrict their sale in order to limit the losses to which retail investors are exposed.
On 1 June 2018, ESMA formally adopted these new measures to restrict the trade of these products. However, it is only able to implement these measures for up to three months at a time. ESMA will, therefore, need to decide on a three monthly basis whether to extend and/or vary the applicability of these measures on an ongoing basis.
The new measures
The restrictions are as follows:
1. Binary options – a prohibition on the marketing, distribution or sale of binary options to retail investors.
2. CFDs – a restriction on the marketing, distribution or sale of CFDs to retail investors. The restriction consists of:
a. leverage limits on opening positions, from 30:1 to 2:1, varying according to the volatility of the underlying asset.
b. a margin close out rule on a per account basis. This aims to standardise the percentage of margin (at 50% of minimum required margin) at which providers are required to close out one or more retail client's open CFDs.
c. a negative balance protection on a per account basis, to provide an overall guaranteed limit on retail client losses
d. a restriction on the incentives offered to trade CFDs
e. a standardised risk warning, including the percentage of losses on a CFD provider’s retail investor accounts.
According to the Chair of ESMA, the measures "are a significant step towards greater investor protection in the EU. 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 understandable risk warnings for investors. ESMA’s prohibition on the marketing, distribution or sale of binary options to retail investors addresses the significant investor protection concerns caused by the characteristics of this product. This pan-EU approach is the most appropriate way to address this major investor protection issue."
Alongside its announcement, ESMA has published a Notice of its Product Intervention Decisions in relation to CFDs and binary options, detailing the decisions taken. ESMA has also published separate Product Information Analyses on binary options and CFDs, analysing evidence in relation to the provision of both products and the effect of proposed changes.
The FCA's Business Plan for this year, published in April 2018, expressed support for ESMA's intervention measures and stated that the FCA expects to consult on whether to apply ESMA's measures on a permanent basis, even if ESMA were to withdraw these restrictions in due course.
The FCA will no doubt be paying close attention to firms' responses to these measures and their impact on retail customers and will be liaising with ESMA in this regard.
Therefore, firms in this sector should be quick to respond to these changes to avoid the FCA knocking at their door in due course and expect CFDs to remain under the FCA's microscope for the foreseeable future.