5COMPLY

GABRIEL STYLLAS CEO and Founder of 5COMPLY

Introduction

It’s been 2 years now since European Securities and Markets Authority’s (“ESMA”) first introduced the temporary ESMA product intervention measures on Contracts for Differences (“CFDs”) with restriction on the marketing, distribution or sale of CFDs to retail investors. This restriction 2 years ago introduced: 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.

Although ESMA’S intervention was originally drafted as being “temporary”, National Competent Authorities (NCAs) about a year ago published their National Product Intervention Measures in relation to the marketing, distribution and sale of CFDs by issuing relevant local legislation. The measures of NCAs were largely aligned with the ESMA’s temporary product intervention measures.

The intention

Obviously ESMA’s aim was to protect retail investors, as consumers, from what ESMA perceived to be products that are perceived to have adverse consequences for certain retail investors. ESMA’s goal was certainly to protect the EU retail clients and it seems most of the restrictions were towards the right direction e.g. negative balance protection and risk warnings. The measures on CFDs ensure that investors cannot lose more money than they put in, restrict the use of leverage and incentives, and provide understandable risk warnings for investors.

The Outcome - two years later

Since the introduction of ESMA’s temporary intervention measures the big majority of EU retail clients have set up accounts with CFD brokers that are established outside the EU. It seems that traders were looking for offshore brokers and they were willing to accept the additional risks involved.

Gabriel Styllas CEO and Founder of 5COMPLY

Although It is only on the traders’ own initiative that an account can be set up with a CFD broker that is established outside of the EU this was not always the case.

Two years later the results are disappointing as the big majority of EU retail clients, ESMA wanted to protect have already moved the relationship, to permitted jurisdictions that could offer them higher leverage, even though most of the times there are no investor compensation funds available and no negative balance protection.

Bottom line the retail clients who want to get higher leverage most of the times are ready to get higher risks as well and unfortunately sometimes they are ready to move to brokers that they are not regulated at all.

Who are the winners

Some offshore regulators like Seychelles FSA and Mauritius FSC managed to attract many new brokers (mainly EU brokers that would like to offer their

clients the option to get higher leverage). These regulators managed to get some knowhow, improve and develop during the last 2 years, with the aim to attract as many credible brokers as possible by offering higher leverage; however, at the same time these regulators want to improve their reputation, image and credibility and further develop their AML legislation to be in line with the EU legislation.

Who are the losers

Unfortunately, some EU Retail clients had very bad experience with some non EU brokers (mainly non-regulated brokers), while trying to set up accounts with brokers offering higher leverage.

Two years after the introduction of the temporary ESMA product intervention measures on CFDs, National Competent Authorities only supervise a small number of EU retail client trading CFDs thus ESMA it’s not possible any more to protect the majority of EU retail clients. During the past the EU brokers had agreements in place with the big majority of EU retail clients trading CFDs and thus National Competent Authorities could protect the EU retail clients through the supervision of EU brokers. However, this is not the case anymore as most of the EU retail clients maintain relationships with brokers that are not under the supervision of the NCAs.

Summary - What ESMA could have done better

ESMA’s original intentions were really good and most of the restrictions are towards the right direction. The measures on CFDs ensure that investors cannot lose more money than they put in, restrict the use of leverage and incentives, and provide understandable risk warnings for investors.

However, the leverage restrictions were steep and extremely strict and this was the main reason that most of the EU clients are not cooperating with EU brokers any more.

In case ESMA’s leverage restrictions were less strict and at more reasonable limits and even if all the remaining ESMA product intervention measures on CFDs remained the same, the EU CFDs industry would be much different today. The EU retail clients would never move to non EU brokers and thus would enjoy more and better protection under the supervision of ESMA and the NCAs. It’s never too late to relax some of the leverage restrictions.