CFD providers prepare for potential client shift to unregulated entities

Providers of FX contracts for differences will be monitoring their trading volumes closely over the coming weeks to see whether warnings of clients moving to unregulated providers come to pass.

The European Securities and Markets Authority (ESMA) measures restricting the marketing, distribution or sale of contracts for difference (CFDs) to retail investors took effect from 1 August.

The measures include leverage limits on opening positions (30:1 for major currency pairs and 20:1 for non-major currency pairs); 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.

Trading platform Capital.com says analysis undertaken following its decision to reduce its default rates across currencies from 1 June reveals that users who traded using the lower leverage limits were significantly less likely to face a margin call.

The proportion of users facing a margin call within the first 15 days of trading fell from approximately 30% in the months before the platform introduced the ESMA limits, to 5% in June. The size of the average loss fell by more than 80%.

However, the CFD providers contacted by Euromoney were far from unanimous in their approval for the measures taken by ESMA –particularly in relation to limiting leverage. For example, Omar Arnaout, CEO of XTB, describes the leverage restrictions as too severe and fears they will encourage some European-based clients to trade with non-EU brokers.

“Traders should be aware that different licences provide different levels of security for investors,” he says, adding that he expects the new restrictions to accelerate consolidation in the sector.

CFDs may still be marketed, distributed and sold to professional clients, although ESMA has warned retail investors to consider very carefully whether they should adopt professional client status and lose the extra regulatory protections afforded to retail clients.

An IG Group spokesperson says it is clear that the ESMA restrictions have been deeply unpopular with clients and that some have applied for professional status. “For such a high number to apply before the rules are even in force is extraordinary, but we are very strict in our application of the rules that allow clients to elect to be professional and have rejected more than three quarters of applicants.”

Richard Perry, market analyst at Hantec Markets, says his firm has also seen an increase in applications from retail clients to be reclassified. “Whether this is considered a way to ‘get around’ the restrictions or just clients becoming aware of the options available to them is open to debate,” he adds. “It is important that these clients are made aware of the protections they lose by becoming a professional.”

A spokeswoman for FXCM says the firm anticipates some drop in trading volumes from its European clients but adds that its customers will continue to appreciate that spot FX and CFD trading provide advantages over trading futures contracts.

“Separately, there seems to be some amount of political charge to the new rules and political winds change,” she adds. “I hope that at some point in the future the restrictive margin requirements will be rolled back to the more reasonable levels established in other jurisdictions.”

Saxo Bank founder and CEO, Kim Fournais, acknowledges concerns that more prudent consumer protection will lead to increased activity from unlicensed providers from outside of the EU. However, he also suggests that this is an issue that should fall within the remit of the police and relevant authorities and does not represent a valid argument against firm and fair regulation.

ESMA says it will review the new measures and consider the need to extend them for a further three months before the end of October. CFDs are generally expected to be under the intervention measures for between six to nine months before the regulation is handed back to local national conduct authorities, Perry says. Those authorities will then assess whether to increase the leverage limits or stick with those imposed by ESMA.

“The hope is that the measures will have the anticipated impact and that standards within the industry will increase,” he concludes. “I believe that client complaints to the ombudsman are at an all-time low, so although moves to ‘tidy up’ the industry are a positive development in the long run, it still seems like a bit of a knee-jerk reaction.”