The European Securities and Markets Authority (ESMA) is consulting with brokers about a potential new regulatory regime which will affect the way CFDs (contracts for difference) are sold in the European Union. There are a number of issues up for discussion affecting how much leverage CFD brokers give to retail clients, a margin close out rule and some kind of negative balance protection that could be applied on a per account basis.
Ultimately, European regulators are becoming concerned that CFDs as they stand may be too risky for some private investors who do not understand them properly.
ESMA CFD concerns: more to be done, says regulator
Another issue is incentivisation provided by brokers to get investors to trade more than they need to. ESMA says that it is seeing a rapid rise in the marketing of CFDs in Europe, including such products as rolling spot forex and binary options. We have already noticed a move by European regulators to ban the advertising of binary options trading in the EU, which has also led to many brokers taking binaries off the table entirely.
Some national regulators have also been researching the use of CFDs by the retail market and estimate that many investors consistently lose money while trading CFDs.
ESMA is proposing leverage limits in the range of 30:1 down to 5:1, depending on the type of asset class being traded. It also wants to see some kind of standard level of margin exposure at which brokers would be obliged to close out trades.
Binary options trading faces total ban in Europe
Binary options are facing an almost complete and total ban. The proposals do not come as a huge surprise for many brokers, as they expected something of the sort was in the pipeline. There is a question, however, about whether new regulations would be needed, as some of the concerns are being addressed by the new MiFID II European directive, which came into force at the start of this year.
Some lawyers are already arguing that any future regime should seek to improve the current treatment of CFD trading and the protection of consumers, rather than simply opt for an out and out ban. They are urging brokers to engage with ESMA’s call for evidence, which needs to be submitted by February 5 this year.
FCA concerned following review of CFD brokers
The FCA has already said it has serious concerns about some parts of the CFD broking industry. In a statement issued last week, the regulator said it was worried that some brokers were still not taking the time to identify whether traders have enough experience to start opening CFD accounts. Some brokers are also not sufficiently policing conflicts of interest – e.g. ensuring some tasks like compliance are being carried out independently.
Many of the issues raised by the FCA are common ones across the financial services industry, and the UK regulator regularly addresses these themes in its inspections of companies. The European initiative, on the other hand, will mean that brokers will have to spend more time getting a better understanding of investors before allowing them to open CFD accounts.