Poland's financial supervision authority Komisja Nadzoru Finansowego (KNF)
The European Securities and Markets Authority (Esma) recently confirmed it would not renew the temporary restriction on the marketing, distribution or sale of CFDs to retail clients in the EU.
A spokesperson for the securities markets regulator said this decision was taken on the basis that most national competent authorities (NCAs) had taken permanent, national product intervention measures that were at least as stringent as Esma’s.
The only notable outlier is Poland, where the financial supervision authority Komisja Nadzoru Finansowego (KNF) decided to introduce an additional level between retail and professional status – ‘experienced’ – where clients can trade with a maximum leverage of 1:100.
The KNF justified the lower margin requirement by referencing the results of surveys conducted by the authority and a Polish association of investment firms, which it said indicated that many Polish clients had opened an account with a broker registered outside of the EU to access higher leverage.
It is impossible to know the exact extent to which this has happened, since offshore brokers don’t report their client numbers or volumes.
However, FXCM CEO Brendan Callan notes an increase in applications for licences in jurisdictions such as Mauritius, Seychelles and Gibraltar.
Anthony Sharpe, head of compliance at Hantec Markets, observes that most regulated brokers now have an offshore organization where retail clients can trade at the previous leverage limits.
“This has added a little more integrity to offshore trading, as traders can use reputable companies,” he says.
“However, the ultimate aim of protecting retail clients has completely failed, with traders now trading under the same terms they were prior to the intervention, but with none of the protections afforded to them under EU regulations.”
XTB experienced a decline of more than 15% in active client numbers in the immediate aftermath of the measures taken by Esma in August 2018, says its CEO Omar Arnaout.
A report published by the US National Bureau of Economic Research in late 2017 and updated in June this year found that leverage caps in the US retail FX market had lowered high leverage traders’ losses by 40%.
Esma may have been encouraged by the observation of the report’s authors that overconfident traders are disproportionately attracted to markets with high leverage and typically generate poor net returns.
It might also have noted the report’s conclusion that “the growth of the foreign exchange brokerage market has been socially excessive and that a leverage constraint policy is an effective tool to reduce this excess”.
However, feedback from brokers suggests the EU leverage limit has had minimal impact on retail client profitability.
“Our average percentage of profitable clients per quarter since the new rules were introduced is 26.6%, which is very close to the pre-intervention ratio of 28%,” says FXCM’s Callan. “The biggest factor in client profitability is volatility, not leverage.”
XTB’s Arnaout says the change in profitability at his firm has also been limited.
“Prior to Esma’s intervention, just under 71% of our clients lost money,” he adds. “Over the following 12 months, just under 65% of clients lost money.”
A number of brokers reported an increase in applications for professional client status after the imposition of leverage limits for retail clients.
“The number of professional clients has increased since the intervention measures came into force, although those Mifid brokers adhering to the definition of a professional client and ensuring their clients are sufficiently qualified would not have seen a huge percentage increase,” suggests Hantec’s Sharpe.
However, while acknowledging that few if any brokers would have more than 10% of their client base classified as professional clients, he says the percentage would still have been influenced significantly by the number of retail clients that have stopped trading or moved to an offshore broker in search of higher leverage.
“We are certainly aware that a number of our competitors made a proactive push to encourage clients to opt for professional status and therefore have much larger numbers of clients that have done so,” says Callan.
“We also understand that those firms are receiving a good deal of scrutiny from regulators and may end up being required to reclassify clients back to retail.”
In July, Esma said it would – along with NCAs – “continue to monitor compliance of CFD providers with the product intervention decisions”.
A crackdown on EU-based providers moving clients to intra-group third country organizations outside the scope of the regulations could be the next battleground in this segment of the FX market.