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How ESMA’s New Regulations Change the Trading Landscape

How ESMA Regulations are Changing the Trading Landscape

On the 1st of August, 2018 the rules dramatically changed for trading firms and their clients in Europe. The European Securities and Markets Authority (ESMA) enacted its product intervention powers to set the industry on a new path, with more robust protection for clients and more stringent rules for retail brokers.

Not only are retail traders now facing higher margins and correspondingly less leverage to use when placing trades. Retail brokers must now follow a new set of stricter rules that protect their client’s capital.

Why is ESMA changing the rules?

After ESMA was created on the 1st of January 2011, it focused on regulating the Credit Rating Agencies following the 2008 Financial Crisis and ensuring that the existing legislation was adhered to in the rest of the industry. When the Swiss National Bank dropped its Euro peg of 1.20 in January 2015, many retails traders were caught positioned long in the market. Within minutes prices fell from 1.20 to 0.75 before eventually settling at 1.00. By this time the damage was done, thousands of traders had been wiped out with the result that some high profile FX brokerages were forced to cease operating and file for insolvency.

This event proved that the industry was operating under a set of rules that offered scant protection to clients and exposed the financial system to increased risk during times of high volatility. ESMA could only react to this situation by investigating the industry and planning reforms to prevent similar issues arising in the future.

When MiFID II was enacted the accompanying piece of legislation, the Regulation on Markets in Financial Instruments and Amending Regulation (“MiFIR”), enabled ESMA to amend the regulations and change the how the industry operates.

What are the changes since the 1st of August 2018?

  1. Binary Options: A prohibition on the marketing, distribution or sale of Binary options to retail investors and traders.
  2. Contracts for Difference (CFDs): 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.

This means that Binary Options are effectively banned while CFDs are dramatically changed under the new regulations.


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From the 1st of August 2018 the five changes to CFDs include:

  1. Leverage limits on the opening of a position by a retail client, 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;
  1. 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;
  2. Negative balance protection on a per account basis. This will provide an overall guaranteed limit on retail client losses;
  3. A restriction on the incentives offered to trade CFDs; and
  4. A standardised risk warning, including the percentage of losses on a CFD provider’s retail investor accounts.

These rules cover leveraged products including spread betting and are imposed on retail traders and clients. Professional traders are exempt from these rules.  

What are the changes for Brokers?

Brokers offering products are faced with a number of changes concerning how they interact with clients, how they manage client accounts and how they operate. This includes a prohibition on the offering of bonuses, incentives, discounts and rebates to traders for opening more trades or trading with a bigger stake size.

Brokers must protect client’s accounts more

Brokers now have to use more resources to manage their client’s accounts to prevent a negative balance and implement negative balance protection measures. They also have to ensure that individual trades are kept above the minimum margin requirements and that traders have sufficient funds to meet that level in their accounts. Automated closure of trades occurs when the account balance is at 50% of the margin required for those trades to be opened.

Brokers must display standard warnings

Brokers are also required to display a standard warning to their clients that informs them of the risks associated with trading and what percentage of their clients lose money trading the financial markets. This message is also displayed on advertising and marketing material.

Different business models and marketing campaigns

These changes have an impact on the business model for brokers, with some affected worse than others. Many have launched new marketing campaigns to draw new clients in and are offering more educational material and trading tools to help their clients become more profitable and last longer trading the markets. This implies that the broker wants their client to succeed and is trying to develop a stronger relationship with customers. This has put pressure on the no frill, low cost approach taken by some brokers, whose clients are under pressure from margin requirement rules.

Brokers are now facing a decline in the volume of trades as traders are now trading with less margin to open new positions. With some traders abandoning their careers in day trading and others opening accounts with unregulated brokers outside EU jurisdiction, the industry is being squeezed with the fear that many brokerages operating within the EU will go out of business.

What are the changes for Clients/Traders?

Clients and traders are facing the changes of having to now trade on higher margin and leverage costs. The trade off is that clients now have more protection than ever before but are more restricted in the risk that they can take. In essence the dreams of “getting rich quick” have had the brakes applied.

However a group of traders are exempted from these restrictions and are trading the same as before. This is known as the Professional Trader category. Many existing retail traders are trying to qualify for this group and avoid the impact of the new ESMA restrictions.

The qualification criteria are as follows and prospective applicants must meet two of the three conditions:

  1. Size of Portfolio – The size of the trader’s portfolio of investments exceeds EUR 500,000. This portfolio can include Stocks owned, Cash savings, Mutual funds and Trading accounts. Property, Jewellery, Luxury cars, Company pensions or Non-tradable assets are not included when this assessment is made.
  2. Professional Experience – A trader must work or have worked in the financial industry for a minimum of one year in a position that requires knowledge of financial products. This is to satisfy the requirement for sufficient knowledge on the part of the trader to understand the risk profile of the products traded..
  3. Trade Size and Volume – The trader must have traded in size of at least ten times each quarter during the past four quarters in a relevant product. Significant size is defined as EUR 50,000 on FX, Commodities and Indices and EUR 10,000 on an individual Stock. Relevant products include Futures, Options, Binary Options, CFDs, FX or Warrants.

Brokers are prohibited from canvassing clients and offering professional status because the change in status removes some of the rights retail traders enjoy. These include:

  • Negative Balance Protection – losses may exceed deposits and if the balance in the account is negative the trader will be required to make a payment to restore the balance to a positive number.
  • Risk Warnings – it is assumed that the trader already understands the risks associated with trading the particular product.
  • Leverage Restrictions – the new leverage restrictions that now apply to retail traders do not apply to professional traders.
  • Product Restrictions – it is assumed that the trader understands the risk associated with trading complex financial products that are high risk.
  • Communication – it is assumed that the professional trader has carried out a diligent study of the risk associated with trading financial products and has acquired the knowledge and experience to operate freely in the markets without broker input.

Other traders that cannot qualify for professional status are taking the drastic option of setting up accounts with brokerages operating in countries that are outside of the EU and ESMA jurisdiction. This action carries huge risks as those brokers may not offer the rights extended to retail and/or professional traders operating in the EU. There is also the additional currency exchange risk associated with opening an account in a foreign currency, with the account balance being subject to exchange rate fluctuations and transaction fees.

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