Out-Law / Your Daily Need-To-Know

Spread betting firms urged to get involved in EU call for evidence on intervention

Out-Law News | 19 Jan 2018 | 10:30 am | 2 min. read

EU regulators have set out proposals to restrict or prohibit the marketing or sale of certain contracts for difference (CFD) financial products to non-sophisticated investors.

The European Securities and Markets Authority (ESMA) is particularly keen to hear from firms and investors about its plans to introduce leverage limits and standardised risk warnings on CFDs sold to retail investors, including on cryptocurrency CFDs. It is also seeking views on whether to prohibit the sale of so-called 'binary options' to these investors entirely.

The consultation comes after warnings about the risks associated with these products from both ESMA and national financial regulators, including the UK's Financial Conduct Authority (FCA). It closes on 5 February 2018.

Financial regulation expert Michael Ruck of Pinsent Masons, the law firm behind Out-Law.com, said that the call for evidence would not come as a surprise to many in light of recent announcements from the regulators.

"Whilst the view of regulators, including ESMA, in relation to CFDs, binary options and spread betting appears to be negative, the key consideration for the regulators should be to identify where improvements can be made without inappropriately restricting or removing an individual's ability to access these investments," he said.

"There is a risk that the actions of some parties involved in the creation, promotion or sale of such products negatively impacts others who are seeking to meet the relevant regulatory requirements. This all goes to show that those within the industry not only need to engage with the call for evidence, and regulators more widely, but to prepare themselves for ongoing intensive scrutiny and potential intervention from regulators," he said.

CFDs are complex financial instruments offered by investment firms, often through online platforms, which include the likes of 'spread bet' and rolling spot foreign exchange products. They are a type of derivative which effectively enable investors to bet on the extent to which the value of an underlying asset such as equity shares, foreign exchange rates or cryptocurrency, will rise or fall. For a small deposit, traders will place the bets on behalf of customers at leverage rates of as much as 200:1, which can cause financial detriment if the bet fails.

Among the proposals put forward by ESMA for consultation are leverage limits ranging between 30:1 and 5:1, depending on the historical price behaviour of the underlying asset. It is also considering a 'margin close out' rule, which would require the provider to close a retail customer's open CFD when the value drops below a certain percentage of the original stake. The percentage would be standardised across providers. 'Negative balance protection' on a per account basis would provide an overall guaranteed limit on retail client losses.

The proposals also include standardised risk warnings, to include an indication of the range of losses on retail investor accounts, and restrictions on a provider's ability to offer incentives to retail clients either directly or indirectly. Separately, ESMA is seeking views on the extent to which to extend these proposals to CFDs in cryptocurrencies, or potentially to prohibit the sale of CFDs in cryptocurrencies to retail clients altogether.

ESMA is considering a total ban on the marketing, distribution or sale of binary options to retail clients. The regulator believes that there are "inherent features" of these products that are "unlikely to be sufficiently addressed" through less restrictive measures.

"In particular, the pricing structure of the product means that, on average, investors will experience negative expected returns without providing any clear compensating benefits to retail investors," it said in its consultation paper.

As previously announced, ESMA would introduce the measures using its new product intervention powers under article 40 of the Markets in Financial Infrastructures Regulation (MiFIR). MiFIR came into force across the EU on 3 January 2018.