The European Securities and Markets Authority, otherwise known as ESMA, has proposed a series of new restrictions on the way CFDs or contracts for difference, will work within the European Union.

The new ESMA leverage restrictions will focus in particular on the amounts of leverage that brokers can offer to CFD traders and also place limits on the amount of money traders can lose on a margined CFD trade.

On top of this an outright ban on the sale and promotion of binary options has been announced. Brokers across Europe will have to make use of a standardised risk warning.

ESMA leverage restrictions

CFD brokers will now have caps applied to the amount of leverage they can offer to CFD traders and will have to make use of a standardised close out level of 50% of the required margin of a trade. This is being introduced to stop CFD traders from losing large amounts of money, potentially more than they have committed to the trade, or having trades closed unexpectedly as the result of a margin call.

Negative balance protection is also being made compulsory as part of the ESMA leverage restrictions. This means that brokers will have to provide a guaranteed limit on losses. Some brokers had already introduced this for their clients. CFD brokers will now be forbidden to incentivise clients to trade more.

“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 risk warning for investors,” explained Steven Maijoor, the ESMA chairman.

The changes are being brought in as part of what are called ‘temporary product intervention measures’ which ESMA has the authority to do. While they have yet to be implemented by the FCA, the UK’s financial regulator did say that it would be consulting on whether the restrictions should be applied permanently.

Some ESMA leverage restrictions implemented voluntarily

Some of the changes were already being implemented by several CFD brokers on a voluntary basis. The ban on binary options comes as no particular surprise, as individual European markets had been introducing restrictions on these last year, and numerous brokers had dropped binary options.

This is the first time that ESMA has exercised its product intervention powers since it received them as part of the MiFIR directive, which came into force on 3 January of this year. ESMA received intensive lobbying from CFD brokers along with over 14,000 members of the public, many of them active CFD traders.

The new powers were only provided to ESMA on condition that they would be used sparingly and only after the other regulators. Instead European brokers are having to react to a decision by a supranational entity. It will be interesting to see whether the FCA decides to implement the changes on a permanent basis, particularly as the UK will be leaving the EU in the near future and will no longer be subject to ESMA after this.

One major concern is that many CFD traders will look to open offshore CFD trading accounts with brokers that are not regulated inside the EU. A survey by IG of 3,300 trading clients found that 80% would consider opening an offshore CFD trading account in the event of new restrictions on CFD trading.

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27th March 2018
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