ESMA restrictions

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ESMA Extends Restrictions for Binary Options

The decision was officially adopted on September 21, 2020, and will be effective starting this Tuesday.

The European Securities and Markets Authority (ESMA) announced on Monday that it has agreed to extend the restrictions for binary options which prohibits the marketing, distribution or sale of binary options to retail investors.

The decision, which does not come as a surprise to the markets, was adopted on September 21, 2020, and will be effective from this Tuesday, October 2, 2020, for a period of three months until the end of this year.

The pan-European regulator initially announced that it would renew its restrictions on binary options back in August this year. At the same time, the regulator also announced some changes to the renewal.

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In August, ESMA identified that some binary options do not pose a significant threat to retail investors and are therefore no longer included in the scope of the measures. Specifically, the watchdog decided that binary options that are long-term investments (at least 90 days), that are accompanied by a prospectus and that are completely hedged by the provider or another entity in the same group, are less likely to cause significant harm to investors.

In addition, in August the regulator has also stated that binary options which have one of two predetermined payouts at the end of the term, neither of which is less than the initial investment of the trader, will be excluded.

ESMA Renews CFD Restrictions for Retail Traders

The renewal of the binary options restrictions follows on the back of the heels of the regulator announcing on Friday that it will extend its restrictions on the sale, distribution, and marketing of contracts for differences (CFDs), as Finance Magnates reported .

The renewal will come into effect from November 1, 2020, and will last for three months until January next year. According to the rationale from ESMA, the watchdog extended the measures because “significant investor protection concern related to the offer of CFDs to retail clients continues to exist”.

ESMA – Product Intervention

ESMA has intervened and set the new regulatory playing field for traders and providers of Contracts for Differences (CFDs) and FX.

In this post we first outline the new regulation, and then review the consequences for:

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  1. Darwinex
  2. DARWIN Investors
  3. DARWIN Providers (aka traders)
    1. Investable
    2. Not (yet) investable
  4. Brokers & Broker-dealers

ESMA rules

ESMA published its official statement on this link , but here are the measures in a nutshell.

It’s the end of an era

First: bye bye, binary options.

Second: bye bye, wild west CFDs

  1. Leverage limits on the opening of a position by a retail client from 30:1 to 2:1, which vary according to the volatility of the underlying:
    1. 30:1 for major currency pairs;
    2. 20:1 for non-major currency pairs, gold and major indices;
    3. 10:1 for commodities other than gold and non-major equity indices;
    4. 5:1 for individual equities and other reference values;
    5. 2:1 for cryptocurrencies;
  2. A margin close out rule on a per account basis. This will 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;
  3. Negative balance protection on a per account basis. This will provide an overall guaranteed limit on retail client losses;
  4. A restriction on the incentives offered to trade CFDs; and
  5. A standardised risk warning, including the percentage of losses on a CFD provider’s retail investor accounts.

Impact on Darwinex

Let’s first review the items one by one – and then overall.

Item

Our thoughts

Leverage restrictions
  1. Reduces structural risk – we’ll sleep better on lower leverage
  2. No impact on DARWIN investors / traders
  3. Risk to drive some trader business offshore
Margin close-out

Great improvement from previous “per-trade” suggestions – saved a lot of development resources on this one!

Negative Balance Protection

A red-herring – probability of negative balances on new leverage very limited. Requires regulatory status change for brokers.

Restriction on incentives

We’ve never provided them!

Standardised Risk Warning

Overall, we had argued that forcing CFDs on Exchange would fix CFDs once and for all… but this hasn’t happened yet.

Meanwhile, 2 takeaways for Darwinex:

  1. Competition no longer imposes leverage levels harmful to both us and customers
  2. We’re upgrading our matched principal to a full-scope broker-dealer permission

We have argued that a conflict free, agency only model is the most transparent way to align incentives with customers. ESMA preferred to “invent” negative balance protection instead… so we’re upgrading our regulatory permission to a full-scope broker-dealer.

We’re doing this because it’s technically impossible to offer negative balance protection and not take market risk… but: rest assured that Darwinex will leverage its new license to disrupt brokerage further! More on that when the time comes ��

ESMA intervention for DARWIN investors

This one’s quick ��

In a nutshell: no impact

  1. The new target leverage levels that ESMA has now finalised are above the maximum leverage thresholds that the risk manager would tolerate
  2. Leverage limits apply at a DARWIN portfolio (not DARWIN individual) level – this adds extra breathing room

So, what about traders?

ESMA intervention for traders

We expect the European CFD market to

  1. Shrink: somewhat in the short-term: less gambling advertising budgets will flow into CFDs, and will go elsewhere (online gambling, crypto, offshore, etc.)
  2. Mature: bucket-shops will finally go away, and with them the regulatory stigma that’s hurt the entire sector.

Overall we remain bullish on retail trading: financial markets remain the highest payout game out there. With tighter controls, the general public (and regulators) will realise that the problem was not CFDs, but wild-west CFDs.

Volumes will eventually come back, stronger – just like when other jurisdictions (Singapore, Japan, etc.) restricted leverage.

Investable traders

For good traders, ESMA tilts the balance:

  1. Away from borrowing debt capital from brokers,
  2. Towards investor equity capital (unlimited, healthy leverage)

Which is another of saying: broker leverage is limited, but with a high capacity, high quality DARWIN, investor leverage is infinite , in addition to risk-free .

We have a vested interest in saying this, but hey, DARWINs are now more appealing than ever . We look forward to more investable managers leveraging the DARWIN Exchange to tap into investor capital – it’s a win-win for them and their investors!

(Future) Investable traders

… are arguably the biggest beneficiaries.

Lower leverage offers:

  1. Longer learning curves : newbies won’t fritter their accounts away into leverage. This will buy them more time to learn how markets work… and work-out winning strategies that are worthy of investor capital
  2. Lower advertisement budgets : b-book profitability will dramatically fall. This, together with bans on bonuses and advertising, will reduce the amount of ignorant innocents who approach markets with the wrong mind-set

Brokers & Broker-dealers

As discussed above, there will just be broker-dealers going forward.

Darwinex will formally graduate from broker to full-blown broker-dealer, and continue to drive trader evolution in just the same way as for the last 6 years.

Let us wholeheartedly thank all of those who’ve helped us grow from small start-up to consolidated player in the industry since then. Thanks to your trust, there’s meanwhile 45 employees delivering technology, customer service and education to traders worldwide.

ESMA or no ESMA; the future belongs to the independent trader movement, and we’re grateful to act as your humble servants!

ESMA Extends CFD Restrictions for another Three Months

The European Securities and Markets Authority (ESMA) has agreed to extend its restrictions on marketing, distribution or sale of Contract for Difference (CFD) agreements to retail clients to another three months. The renewed restrictions will be applicable from May 1, 2020.

ESMA moves according to anticipation

The industry was anticipating the authority to extend its CFD sale, distribution, and marketing restrictions to retail clients. The authority said that there is still a significant concern for investor protection in the CFD market because of which they have decided to renew the restrictions. The ESMA has previously renewed these restrictions on February 1, 2020, and the new prohibition will follow the same terms.

The clients will continue to face leverage limits on opening a position from 30:1 to 2:1. However, it will depend on the volatility of the underlying asset. Overall, the leverage cap will be limited to 2x for digital currencies and 30x for major fiat currency pairs. Non-major currency pairs, gold, and major indices will stick to 20x leverage, commodities other than gold and non-major equity indices will be limited to 10x and individual equities and other reference values will be limited to 5x leverage.

What should users expect?

The rules will be similar to the February 1 extension which means that there will be restrictions on margin closeout rule on a per account basis. This will help in standardizing the percentage of margin, which comes at a 50% of the minimum required margin) at which providers will be required to close out one or more open CFDs of the retail client.

There will be no protection for negative balance on a per account basis. Additionally, there will be a restriction on incentives offered to trade CFDs. Brokerages offering contracts for difference will also have to provide a standardized risk warning to the investors. The warning must include the percentage of losses on a CFD provider’s retail investor accounts.

Several EU member states are working aggressively towards investor protection measures according to the ESMA’s measures. France is one of the latest examples of this practice. The French financial markets authority AMF announced the opening of consultation regarding restrictions on CFD offerings. It is also considering banning binary options to non-professional investors.

The EU states are working proactively to put more investor protection measures in place along the lines of the ESMA measures. The French guidelines are similar to the ESMA rules but are designed to provide more stringent protections at the national level.

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About CryptoVibes

Sherlock Gomes

Sherlock Gomes has been writing for FXTimes covering Cryptocurrencies and Forex news for 2 years now. Also known as ‘Sherlock’, Viraj comments on the latest businesses emerging in the blockchain industry. His areas of expertise are Bitcoin and Blockchain. He enjoys covering new startups and busting myths across the industry.
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