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ESMA put in place new restrictions on Retail Forex providers.

Draconian or not.  Here they are, new regulations that will go into effect in the Eurozone.  The ESMA (European Securities and Markets Authority) has new policies that they will enforce upon brokers located and serving the Eurozone.  Some of these policies are seen as draconian and others are viewed as necessary.  One in particular is going to be very interesting as it will shatter the false statistics about the industry once and for all.

Retail Forex has a bad reputation.

There is no getting around it.  Retail Forex, CFDs and Binary Options have bad reputations due to the ease that participants entering the market can trade at a laughably low amount with the hopes of creating a larger account.  In the interests of saving $200 depositors from trading at 500:1 leverage or more with maxed out deposit loads that end up resulting in churn-and-burn, the ESMA took action and is taking a similar approach to Japan.

The bad reputation of the industry feeds itself and creates a feedback loop.  ESMA is looking to class up the retail Forex industry and even open the possibility of a more private Forex service for clientele.

Cryptocurrencies being traded on margin have put the industry in the cross-hairs of the regulating body.

What’s Changing?  What are the ESMA’s new restrictions?

First off, the changes that are being introduced will be implemented in the next two months and the ESMA will have the ability to make such intervention measures on a quarterly basis, which means that the interventions could be renewed or revised every three months.

  1. The prohibition of marketing, distribution or sale of binary options to retail investors.
  2. Leverage limits on CFDs, Cryptocurrencies and Rolling Spot Forex (sovereign pairs)
    1. 30:1 leverage limit for Major Currency Pairs
    2. 20:1 leverage limit for Minor Currency Pairs, Gold and Major Indices
    3. 10:1 leverage limit for other commodities (not Gold).
    4. 5:1 leverage limit for individual equities
    5. 2:1 leverage limit for cryptocurrencies
  3. Margin closeouts at 50%
  4. Negative balance protection to ensure that there is a limit on client losses.
  5. Restrictions on incentives to trade CFDs and Forex.
  6. “A standardised risk warning, including the percentage of losses on a CFD provider’s retail investor accounts.”

The words of ESMA Chairman, Steven Majoor:

“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 a risk warning for investors. For binary options, the prohibition we are announcing is needed to protect investors due to the products’ characteristics.

“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.” 

Higher End Clientele is the Future

In the Eurozone, there is no more room for the small trader.  Small traders will end up going to brokerages outside of the Eurozone to get larger leverage and the sportsbook/spread betting experience.  However, the expectation in the Eurozone is that without all of the bells and whistles, the typical methods of luring clientele will give way to a more mature approach.  There will be a shift from a big tent to a prime brokerage sort of approach, which means that the business model changes greatly even if it is a temporary intervention.

The under $5,000 USD depositing client is now a thing of the past in this region.  It’s about selling corporations and middle-to-high net worth clients on diversifying their portfolios.  The objectives are to build partnerships and not leave investors stranded to lose their money.

It means better Introducing Brokers and less reliance upon Affiliates.

The amount of money to be made will be lessened significantly due to the reduced trading volumes.  It could be as large as a reduction of 16 times less revenue and buying power for clients, it could result in higher deposit loads as well.

An example:

  • A trader putting up $1,000 trading margin can have a position of $500,000 (5 standard lots) in the status quo.
  • With the new restrictions:  $1,000 of trading margin can have a position of $30,000 (0.3 standard lots).

Does this impact the rest of the world that does not include the United States, Canada or Japan?  No.

Leverage was not the problem, per se

The problem was the type of client the brokers were bringing into their firms.  The minimums were too far low and the business models were geared to suck the money from clients rather than build up their accounts to generate more revenue from spreads, swaps and interest.  The questions about income, net worth, experience trading and knowledge of the markets were not used in terms of education and the required amount of hand-holding.  Instead, it was a pump, dump, reload business like a sportsbook.

The same objectives could be achieved by simply mandating higher minimum deposits and enforcing a net worth/income rule.  There needed to be a qualification process, but ESMA is far too politically correct to try to intervene like this.  Compare depositors by income level and deposit amounts, the results would not be surprising.

By placing a ban on binary options, limiting advertisements and placing restrictions on leverage, ESMA is dodging the real issues that plague the industry and the Eurozone as a whole.  Unemployment rates in the double digits, fear of not having enough in retirement, absurdly low interest rates and a way out of a tough life is offered through Forex, CFDs and Binary Options.  Derivatives are complex instruments that are not meant to be treated so lightly.  Think it is rough on the Eurozone though?  Try the Middle East, Africa and South Asia where incomes are even lower, caste systems exist and there’s even more desperation.

One very good reform in this intervention

The only appreciable reform that everyone can agree with when it comes to this new intervention is the quarterly profitability report.  Ridding the industry of the myths that can be used by spam peddlers and individuals who prey on the naive is a good thing.  The myths make it seem like there are only a selective few with the answers, when the reality is that approximately 1/3 of retail Forex Traders are profitable on a quarterly basis.  More transparency is a good thing in this industry.