Esma’s retail forex regulation opens up opportunities for larger market players

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The regulation recently adopted by the European Securities and Markets Authority (Esma) around the provision of contracts for difference (CFDs) and binary options to retail investors has raised a furore among retail traders and brokers.

By Anna Fedorova

The new rules prohibit the marketing, distribution and sale of binary options and place notable restrictions on the distribution of CFDs to retail investors.

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Peter Hetherington,
IG

The latter consists of strict leverage limits on opening positions; a margin close-out rule and negative balance protection on a per account basis; preventing the use of incentives by a CFD provider; and an obligation to include a firm-specific risk warning on the marketing material.

The original proposals divided opinion in the market, with some companies supporting the new rules, while many retail traders called the measures “draconian”.

For firms that used to rely on high leverage for profits, the new rules are likely to hit profitability in the short run. For example, UK retail trading platform IG Group has warned in its latest set of results that the new rules could reduce its revenue by around 10% in 2019.

Peter Hetherington, IG chief executive, says: “As Esma’s product intervention measures are focused on the CFD industry, they risk creating an unlevel playing field by giving an advantage to other forms of leveraged trading products which are offered to retail clients.”

According to an IG survey regarding the new rules, 98% of the 14,605 online respondents to the proposals took a negative stance.


Level playing field

However, according to Saxo Bank, the new rules are set to create a level playing field, allowing key market players to compete on other aspects of product and innovation.

“In the UK, Saxo sees a unique opportunity to gain market share, with the new regulation from Esma creating a more level playing field for competition,” states the bank.

“The new Esma rules put a prudent cap on leverage and as Saxo has opted not to compete on high leverage, the company eyes a significant opportunity to compete on core strengths in product, platform, price and service.”

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Harps Sidhu,
KPMG UK

According to KPMG, the new rules align retail trading with the rest of the industry, and should not significantly affect professional firms, which have already had to address client risk in preparation for Mifid II.

Harps Sidhu, partner at KPMG UK, says:“Esma’s latest measures to restrict non-professional exposure to products such as CFDs are aligned to the overall agenda to improve investor protection for retail clients.

“As part of Mifid II implementation, investment firms were required to review their product governance arrangements – including distribution channels and client categorizations. It is likely that many firms concluded that the sale of CFDs and binary options to retail investors was beyond their risk appetite.”

According to Sidhu, the main hit from the regulation will be on financial spread-betting platforms targeting retail investors.

He adds: “There are other factors that define how well those platforms can perform given the tighter requirements, including market volatility, new technology, product development and growth opportunities in other markets.”

New developments

Meanwhile, for banks and multi-asset providers, the regulations open up new opportunities for product development. Recently, Saxo Bank launched SaxoTraderPRO, a new professional-grade trading platform for active traders and institutional clients.

Christian Hammer, head of platforms, said: “We have worked with the latest front-end technologies such as HTML5/JS/React, which connect to a single REST API that clients can also access directly to develop their own bespoke functionality for trading, risk monitoring or reporting purposes.

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Christian Hammer,
Saxo Bank

“We have placed our clients at the centre of the development process with constant feedback, early prototyping and A/B testing with in-lab usability studies. A lot of unique features have been developed based on specific feedback from our beta users like the margin break-down module to help our clients manage their risk.”

Other market players have also been taking advantage. FX liquidity and prime brokerage service provider IS Prime, for example, has begun offering negative balance protection guarantees to retail FX brokers in response to Esma’s regulations.

At the same time, the regulation is pushing some retail brokers, such as CMC Markets, to reposition their businesses to focus more on professional clients that are not affected by the rule changes, as well as converting existing retail clients to professional status if they are eligible.

For a retail trader to switch to professional status, they must prove that they have experience as a financial professional, a portfolio larger than €500,000 or proven trading experience.

Michael Ruck,senior associate for Pinsent Masons LLP, says: “Amongst other changes, the new rules reduce the extent leverage can be utilized to trade, making it much more difficult for experienced traders and those seeking to hedge existing share portfolios.

“This may provide an avenue for larger financial institutions to enter the market, but it is likely that many individuals will seek to identify themselves as ‘professional traders’ to nullify the impact of the new rules.”

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Michael Ruck,
Pinsent Masons

One of the dangers of the regulation is that it may force existing market participants to leave the trading jurisdiction that falls under the scope of Esma’s rules and move to offshore venues, which are often unregulated and therefore carry greater risk for those trading, according to Ruck. 

However, he adds it may also open up opportunities for takeovers for larger firms.

“The prospect of larger financial institutions potentially entering the market may include takeovers of existing market participants, but will be subject to whether the current market participants either seek to move to offshore venues or identify themselves as ‘professional traders’,” he says.