Binary Options & CFDs:

ESMA intervention & FCA response

 

 

 

Retail binary options are to be prohibited under temporary product interventions from the European Securities and Markets Authority (ESMA). Retail Contracts for Difference (CFDs) including rolling spot forex and financial spread bets, also face wide-ranging temporary restrictions from ESMA. The Financial Conduct Authority (FCA) is to consult on permanent intervention measures in the UK.

ESMA confirmed its measures on 27 March 2018, and "in the coming weeks" these will be adopted for publication in the Official Journal (OJ) of the EU. The binary option prohibition will take effect two months later, and the CFD restrictions one month after publication in the OJ.

The FCA on the same day confirmed its support for ESMA's temporary intervention measures, and plans to consult on applying measures on a permanent basis in the UK. FCA intervention in the market is not dependent on the time-limited powers under which ESMA will intervene.

The focus will now turn to whether the FCA will introduce measures as severe as ESMA’s temporary restrictions given the proposals in its earlier consultation.

ESMA's powers

ESMA's interventions will come up for renewal every three months, under Article 40 of the Markets in Financial Instruments Regulation (MiFIR). Consumer protection grounds, transparency and complexity are cited by ESMA. This use of ESMA's new powers was anticipated by AG as long ago as 2015.

There are concerns of overreach by ESMA as it is only permitted to apply its Article 40 powers in specified conditions: including that any threat is not addressed by current regulatory requirements, or not adequately addressed by national regulators. ESMA is also required to ensure that any intervention does not have a disproportionate detrimental effect on investors, and does not create regulatory arbitrage.

There are existing appropriateness tests for retail clients, and product governance rules now mandate appropriate client targeting. National supervisory initiatives concerning CFDs were underway in a number of EU Member States. Further, the risk from CFD providers operating from outside the EU, beyond regulatory reach, is likely to increase.

What's new

Shortly after gaining its MiFIR intervention powers on 3 January 2018, ESMA had launched a call for evidence on proposed interventions on 18 January 2018. ESMA has now confirmed its position, selecting between alternative proposals and with some changes in detail (key changes are highlighted in brackets below). ESMA confirmed, in each case for retail clients:

  • A prohibition on marketing, distribution or sale of binary options; and
  • Restrictions on marketing, distribution or sale of CFDs, including rolling spot forex and financial spread bets:
    • leverage limits on position openings. Limits are specified for various asset classes at between 30:1 for major currency pairs and 2:1 for cryptocurrencies, depending on ESMA's view of underlying asset price volatility. (ESMA had previously proposed a 1:1 leverage cap for cryptocurrencies.)
    • 50% margin close-out, on a per account basis. (ESMA previously preferred a position-by-position margin close-out, to standardise risk across different investments. Based on responses received, it now considers the per account basis to be more proportionate, while ensuring adequate minimum investor protection.)
    • negative balance protection, limiting retail client liability to funds in their CFD trading account
    • prohibition monetary and non-monetary incentives; research and information tool incentives remain permissible; and
    • standardised risk warnings, with firm-specific percentages for client accounts losing money on CFDs over a 12-month period. (ESMA previously preferred warnings indicating the percentage range of accounts having losses based on national analysis; and also considered more abbreviated risk warnings.)

Spread-betting and forex firms in the UK now face a further period of uncertainty for their pricing and business models.

Background

Binary options (BOs) effectively allow betting on the expected value of a financial index, typically over short time periods – under 5 minutes, or sometimes longer. If the specified value is not achieved, the investor loses their money – a "yes/no" proposition. Binary options became a regulated investment product on 3 January 2018 under MiFIR. On 12 January 2018, the FCA published a list of 94 firms without FCA authorisation that it understood to be providing binary options to retail clients.

The FCA had in December 2016 proposed (CP16/40) a tiered approach to leverage restrictions on CFDs: maximum 25:1 leverage (lower than ESMA's confirmed 30:1 cap) for inexperienced retail clients with less than 12 months' active trading knowledge, and a higher maximum leverage cap of 50:1 for all other retail clients. These FCA proposals were put on hold in June 2017, in anticipation of ESMA's wider product intervention powers. Following ESMA's announcement, the FCA is now to resume its UK consultation.

Further information

"The ESMA proposes to use its new banning powers in spread betting and CFD markets", Brian McDonnell, Online Gambling Lawyer, March 2018, pp16-19.

"Spread betting moves up the regulatory agenda", Brian McDonnell, World Online Gambling Report, November 2015, p12.

FCA press release, 27 March 2018

FCA list of unauthorised binary options providers, 12 January 2018

ESMA press release, 27 March 2018

"Additional information on the agreed product intervention measures relating to contracts for differences and binary options", ESMA, 27 March 2018