The wild west days of forex trading have taken one step closer to ending, following this week’s European Securities and Markets Authority (ESMA) publication of its report on the conduct of forex brokers.
ESMA is to prohibit the marketing, distribution and sale of binary options, something that has been long overdue. The fiasco that was unregulated and even regulated binary options trading, brought the spotlight onto online financial trading. There have been massive criminal investigations into the binary options scams with prosecutions made in some high profile cases.
The European Securities and Markets Authority also want to introduce a system of tiered leverage for the different instruments. Despite recommendations and feedback from brokers and their clients, the European regulator decided to limit the leverage choices for retail brokers. All Contracts for Differences (CFDs) offered must adhere to strict requirements and are restricted temporarily to what must be considered a draconian set of rules.
A summary of the ESMA rules are as follows:
- Maximum leverage on forex trading limited to 1:30.
- Maximum leverage on gold trading limited to 1:20.
- Maximum leverage on other commodities limited to 1:10.
- Maximum leverage on stocks limited to 1:5.
- Brokers are required to provide negative balance protection.
- All marketing must clearly display what percentage of clients lose money.
The ban on binary options is expected to be officially implemented within a month after that, while the new restrictions on CFDs affecting regulated forex brokers expected be implemented two months after their publication in the EU’s Official Journal.
The ESMA regulator’s 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 risk warning for investors. For binary options, the prohibition we are announcing is needed to protect investors due to the products’ characteristics.”
Steven Maijoor continued, “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.”
In the whole scheme of things, lower leverage isn't necessarily a bad thing, and negative balance protection is great also for clients. Regulated forex brokers and forex trading in general will need to avoid going down the path of binary options if it wants to avoid further regulations and restrictions in the future.
Disclosure: The author does not own any stakes in the listed equities.
