Belgium ups the ante in regulatory war on leverage for retail FX
Regulators around the world have repeatedly tried to tackle the problem of excessive leverage being freely available to retail, particularly in FX, but Belgium's outright ban on leveraged products is the most radical solution yet.
Belgium's Financial Services and Markets Authority (FSMA) has banned the distribution of binary options, derivatives with maturities of less than an hour and derivatives that use leverage, such as contracts for difference.
The new regulation, which came into effect earlier this month, applies to over-the-counter (OTC) derivative contracts distributed to consumers in Belgium, usually from abroad, via electronic trading platforms.
The ban does not apply to derivatives that are traded on regulated exchanges or on multilateral trading facilities.
It is unusual for Belgium to be taking a lead on this issue because it is usually a follower, says Jeroen Griffioen, managing director at Synechron Business Consulting. However, while excessive retail leverage is a global issue, Belgium has a particular problem.
“At the start of this year it introduced a speculation tax, something that does not exist elsewhere in Europe," he says. "Binary options and CFDs [contracts for difference] were excluded from the tax and that has resulted in a lot more speculation in these instruments in Belgium than you see elsewhere."
In July, the European Securities and Markets Authority (ESMA) sounded the alarm on the aggressive marketing of speculative instruments to retail investors, naming binary options and CFDs as particular areas of concern.
Since the middle of 2015, the Cyprus Securities and Exchanges Commission has imposed fines on, or reached settlement agreements with, eight Cyprus-based institutions, all of which offered FX-related products, and three of which traded FX specifically.
In keeping with ESMA's efforts, Belgium has also banned aggressive marketing, including cold calling and offering inappropriate forms of remuneration, fictitious gifts and bonuses as rewards for distributing these kinds of products.
“The FSMA wants to play a pioneering role by imposing this ban,” says Isabelle Marchand, head of European affairs at Febelfin, the Belgian financial trade association. The pressure is now on the European supervisor to follow suit. “A European ban, of course, would be the most effective solution,” she adds.
Only weeks before Belgium's move, France's Autorité des marchés financiers (AMF) had announced similar measures, banning the advertising of some of the same FX products, including binary options and CFDs. It is also consulting until the end of September about whether any other products ought to be subject to a similar ban.
The problem of excessive leverage for retail FX traders is not covered by the FX code of conduct, which deals specifically with the wholesale market, leaving the retail sector within the scope of consumer protection regulations.
In their different ways, Belgium on the one hand, and France and ESMA on the other, are attempting to plug a gap in the consumer protection regime provided by Mifid, which does not explicitly cover FX. But they have in common a focus on the products themselves, with both approaches underpinned by the idea that limiting retail exposure to certain products is the best way to tackle excessive leverage among retail traders.
Other regulators have tackled the same problem differently. In Australia, where similar concerns have been raised about excessive retail leverage, the Australian Securities and Investments Commission (ASIC) limits the provision of licences to institutions that have demonstrable business ties with the country. It also limits licences for firms offering excessively high amounts of leverage.
ASIC has also noted the increasingly aggressive marketing of leverage to retail. In a compliance review of the retail OTC derivatives sector earlier in the summer, it said: “There has been a material increase in aggressive marketing by issuers of retail OTC derivatives – particularly through cold calling and unsolicited emails – increasing the exposure of these types of products to segments of the Australian population that may not understand the associated risks.”
However, to date, ASIC has not presented new rules governing how such products can be marketed to retail investors, let alone implemented outright bans on trading such products.
The US has taken yet another approach. In 2010 the Commodity Futures Trading Commission (CFTC) introduced a leverage cap of 50 times the principal invested. Japan also introduced a leverage cap in the same year.
However, this has not solved the problem of leveraged FX products being aggressively marketed to retail customers.
Last year, Sharon Bowen, a commissioner at the CFTC, said: “Companies are aggressively marketing [leveraged instruments] to investors. Commercials all over cable, the internet and in print trumpet the money retail investors can make trading foreign currencies, but make little obvious admission of the risks involved.”
Belgium's ban tackles a problem that has been identified by regulators around the world, from a different angle, and if successful it might be expanded. Febelfin's Marchand says: “By taking this measure, the FSMA wants to pave the way for a more encompassing ban.”
Other regulators will also be watching the Belgian experiment with interest. ESMA declined to comment on Belgium's move specifically, but other regulators such as the AMF and ASIC will compare its results to their own efforts. If the latter is more effective in stamping out leverage – and, more importantly, losses – among retail traders, they will surely consider following the FSMA's lead.
Marchand says the FSMA consulted with the sector and made efforts to minimize any potential unintended consequences, such as preventing investors from using the banned derivatives for hedging.
“This measure surely will enhance consumer protection without any negative consequences for other target groups," she says. "Some measures indeed may be a bit over the top, but all in all the sector sees no reason for criticizing them.”
Yet it seems inevitable there will be losers. Some semi-professional day traders, who count as retail investors, will have used CFDs to hedge their positions, and will now face the choice of finding an alternative hedge, or moving to another country.
Synechron's Griffioen says: "This ban will be effective in protecting Belgian retail investors, but it is unfortunate that regulators could not find a Europe-wide solution. A few countries may follow Belgium's lead, but this will certainly make life more difficult for financial institutions in terms of compliance.
"Mifid was supposed to increase regulatory harmonization, but here is another example of it not happening."