The European Securities and Markets Authority (ESMA) has proposed a number of measures to curtail the activities in the retail CFD trading industry.
What is the essence of the measures?
- Significantly reduce the margin availability on all speculative instruments (currencies, stocks, stock indices, commodities).
- A margin close-out rule.
- Negative balance protection
- Measures to stop certain kinds of marketing initiatives (bonus schemes etc)
ESMA has invited the public to respond to these measures, and I hereby do so.
What is the essence of my arguments?
- Draconian measures will drive the CFD industry off-shore and the current problems will be compounded. Yes, it will be removed from ESMA, but the problem will still be present.
- Much less is needed to achieve ESMA’s objectives.
- Negative Balance protection rather than margin changes.
- Binary Options has given a legit industry a bad name. Get rid of them (if you can).
My name is Tom Hougaard. I have been working in the spread betting/CFD industry for 18 years, both as a trader and as a strategist for a CFD firm. In my time in the industry the availability of the product range has exploded. CFD trading (and spread betting) has become readily available to everyone and accessible everywhere through our technological advances.
The product range has expanded to include instruments that deviates significantly from what I call trading. It is here I would like to start my response to ESMA.
If ESMA proposes to ban all Binary Option trading, I think the world of retail trading would be a better place for it. The Binary Option trading has been marketed as an exciting way to make money. The problem with Binary Options is that most people lose because of the way the product is structured.
As my university professor told me in his class on options trading: “statistically, most options buyers end up losing their premium”, which is an academic way of saying that you tend to lose when you buy options. It is the option “seller”, the person who collects the “premium”, who ends up winning – over time. Of course, you don’t have the opportunity of being the “seller” with Binary Options.
I welcome restrictions in the Binary Options arena, because I think the game of binary options is rigged in favour of the broker, who incidentally has every incentive of rigging the game in their favour. It is their algorithms, it is their infrastructure, and the industry is unregulated, so they can do whatever they feel like doing.
I am certain that the CFD industry is being tarnished by the reputation of the Binary Option industry, even though they have very little to do with one another.
The CFD industry has been in existence since IG Markets started in 1970. It lived through many ups and downs in the market, and it is still thriving today in 2018. Although there were losers (and winners) during the booms and busts of the last 50 years, this phenomenon has not been exclusive to the CFD industry. People can lose money on ordinary shares too.
The companies offering CFDs have exploded. They are based all over Europe and beyond. Some have an FCA regulation, some have a CySEC regulation. Some have no regulatory oversight at all. This has created an uneven playing field. Companies regulated by the FCA have had to toe the line and take a much firmer interpretation of the guidelines than its counterparties in Cypress, whilst watching competitors from other jurisdictions engage in activities which has created an unhealthy industry.
The result is that many people who should not have had an account have been able to open an account with firms under a different jurisdiction. I am not pointing fingers at a regulatory body, but pointing out that the villain here is not the product.
What we need is a healthy regulation. I welcome some, BUT absolutely not all, the initiatives from ESMA. I understand the need for regulation, but if you overregulate, you simply export the problem elsewhere.
My biggest concern is that if ESMA implements all their proposed changes to the CFD industry, we will invite companies from other jurisdiction to enter the market and fill the void left behind.
History has taught us that no void is left unfilled. Alcohol consumption didn’t stop nearly 100 years ago just because a ban on the substance was introduced in the US and the stock market didn’t stop falling across the globe (and in England) when the FCA banned short-selling on the 19th September 2008.
I welcome some of the initiatives by ESMA, although some of them are biased towards favouring the client rather than taking a balanced view of the risk the broker has to undertake to run the business.
For example, the “negative balance protection” proposal is designed to stop a client from falling into debt to the broker. It sounds good on paper and on the balance of arguments I welcome it. Jurisdictions like BAFIN in Germany have already implemented this rule. It works. It would stop all of the disaster stories that has surfaced in the last few years.
Of course, it also invites the potential for “moral hazard” trading amongst clients because they know that their downside risk is limited. Still it is a small price to pay for the broker to remain in business, and the regulators wouldn’t have to witness retail clients losing more than they can afford.
If we introduce a European wide “negative balance protection” scheme, do we really need restrictive measures on margin availability? My argument is that we don’t, but I can understand the need for some regulation in this area too.
The average bet size in the industry is £7 a point. If I place a £7 bet on the Dow Jones Index, I currently need to have £900 on my trading account. If ESMA has their way, I will need to have £9100 on my trading account. The consequence of the implementation of the new margins can probably fall into two categories:
1/ the bet size possible will now be so small that no one wants to trade (ESMA will effectively have killed an industry)
2/ the client will seek other vendors who can offer the current margins (ESMA will effectively have driven demand from regulated companies to “cowboys” residing in jurisdictions where the regulatory framework leaves the trader with little or no protection at all).
My proposal is simple:
- Ban Binary Options (which you are unlikely to have success with because they are unregulated, and if people want to find the product, Google will help them) – or restrict their ability to advertise.
- Create Negative Balance Protection across the industry but liaise with the industry to create a common-sense measure, which addresses the problem without leaving the client or the broker at an unfair disadvantage
- If a margin reduction is still needed after point number two is implemented, which I dont think it is, then set margin at 100 to 1. Yes, there will always be “black swan” events, but they will be protected by the negative balance protection. For the vast majority of market moves the client will be able to trade out of the position or get stopped out by a stop-loss order.
ESMA, with the greatest respect, whether you like it or not, you are not going to be successful in your endeavor to reduce the impact of CFDs on retail traders. If your goal is to remove a product from European consumers because you think it is bad for their financial health, then where does it stop? The odds of winning the lottery is pretty slim, much worse than the odds of winning on a trade in a stock market index. Are you going to remove the national lottery too?
What about all the boys and girls that enter drama school around Europe, hoping to become the next big celebrity. Shall we remove drama schools too, because their school fees are high and the odds of becoming a famous actor is incredibly small?
Yes, forgive me for my childish examples, but I feel strongly about taking personal responsibility for my life, and if a man or a woman want to enter the CFD industry in the hope of earning a living and a hobby-income from it, then I fail to understand why anyone can be allowed to stop them from doing so. I know you are not stopping them, but you are in effect rendering the product useless with your proposed changes.
The main problem is that you will not be successful, and you leave the citizens of Europe in a potentially worse situation than before. You may be successful in reducing the desirability of CFDs in the European union, but it would be foolish to think that it wouldn’t result in a “cause and effect” response. Companies from other jurisdictions would enter the market to fill the void. These companies will not carry the same protection that we currently enjoy. You will most likely see many of the existing companies within Europe simply move their operation to another jurisdiction.
ESMA, you are right to do something, but much less is needed to achieve your objective.