ESMA will prohibit binary trading for EU-regulated brands for 3 more months

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ESMA will prohibit binary trading for EU-regulated brands for 3 more months

The European Securities and Markets Authority is an organization that is tasked with “safeguarding the stability of the European Union’s financial system by enhancing the protection of investors and promoting stable and orderly financial markets.” In order to achieve this, the organization issues a rulebook to be followed by EU financial markets. Furthermore, it coordinates the behavior of regulators across various territories.

In July, the organization introduced a prohibition on marketing, distribution and sale of binary options to retail customers. According to a recent press release, the prohibition will be extended to three more months. In addition to the extension, there are some changes made to the list of prohibited products. “ESMA has carefully considered the need to extend the intervention measure currently in effect. ESMA considers that a significant investor protection concern related to the offer of binary options to retail clients continues to exist. It has therefore agreed to renew the prohibition from 2 October,” – said the statement released on the organization’s website.

ESMA excludes select products from the scope of measure

The organization listed several reasons and criteria for considering certain products safer for the investors, thus excluding them from the scope of measure. As the statement explains, there are some binary options that are “sufficiently long-term” in order to reduce the risks for the investors. These options usually have a term of over 90 days. In addition to this, the options have to be accompanied by a well-developed prospectus. A third condition is that the option has to be hedged by the provider i.e. “the binary option [should] not expose the provider to market risk throughout the term of the binary option and the provider or any of its group entities [should] not make a profit or loss from the binary option, other than previously disclosed commissions, transaction fees or other related charges.” If the product satisfies these three conditions, it is considered not as risky for the investor by ESMA.

In addition to these three conditions, there is another instance which might lead the ESMA to exclude a product from the scope of measure. “A binary option for which the lower of the two predetermined fixed amounts is at least equal to the total payment made by a retail client for the binary option, including any commissions, transaction fees and other related costs” will also be excluded from the scope of the renewal. This means that the investor is guaranteed not to lose on the investment. Although there might not be many products that will satisfy the latter condition, it is still considered by the authorities in the renewal of the regulation.

ESMA will prohibit binary trading for EU-regulated brands for 3 more months

The European Securities and Markets Authority (ESMA) has agreed on measures on the provision of contracts for differences (CFDs) and binary options to retail investors in the European Union (EU).

The agreed measures include:

1. Binary Options – a prohibition on the marketing, distribution or sale of binary options to retail investors; and

2. Contracts for Differences – a restriction on the marketing, distribution or sale of CFDs to retail investors. This restriction consists of: leverage limits on opening positions; a margin close out rule on a per account basis; a negative balance protection on a per account basis; preventing the use of incentives by a CFD provider; and a firm specific risk warning delivered in a standardised way.

In accordance with MiFIR, ESMA can only introduce temporary intervention measures on a three monthly basis. Before the end of the three months, ESMA will consider the need to extend the intervention measures for a further three months.

Significant Investor Protection Concern

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ESMA, along with National Competent Authorities (NCAs), concluded that there exists a significant investor protection concern in relation to CFDs and binary options offered to retail investors. This is due to their complexity and lack of transparency; the particular features of CFDs – excessive leverage – and binary options – structural expected negative return and embedded conflict of interest between providers and their clients; the disparity between the expected return and the risk of loss; and issues related to their marketing and distribution.

NCAs’ analyses on CFD trading across different EU jurisdictions shows that 74-89% of retail accounts typically lose money on their investments, with average losses per client ranging from €1,600 to €29,000. NCAs’ analyses for binary options also found consistent losses on retail clients’ accounts.

These measures were agreed by ESMA’s Board of Supervisors on 23 March 2020.

Steven Maijoor, Chair, said:

“The agreed measures ESMA is announcing today will guarantee greater investor protection across the EU by ensuring a common minimum level of protection for retail investors. 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 a risk warning for investors. For binary options, the prohibition we are announcing is needed to protect investors due to the products’ characteristics.

“The combination of the promise of high returns, easy-to-trade digital platforms, in an environment of historical low interest rates has created an offer that appeals to retail investors. However, the inherent complexity of the products and their excessive leverage – in the case of CFDs – has resulted in significant losses for retail investors.

“A pan-EU approach is required given the cross-border nature of these products, and ESMA’s intervention is the most appropriate and efficient tool to address this major investor protection issue.”

CFDs – agreed measures

The product intervention measures ESMA has agreed under Article 40 of the Markets in Financial Instruments Regulation include:

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:

· 30:1 for major currency pairs;

· 20:1 for non-major currency pairs, gold and major indices;

· 10:1 for commodities other than gold and non-major equity indices;

· 5:1 for individual equities and other reference values;

· 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.

Next steps

ESMA intends to adopt these measures in the official languages of the EU in the coming weeks, following which ESMA will publish an official notice on its website. The measures will then be published in the Official Journal of the EU (OJ) and will start to apply one month, for binary options, and two months, for CFDs, after their publication in the OJ.

ESMA will prohibit binary trading for EU-regulated brands for 3 more months

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