Earlier this year, the European Securities and Markets Authority (ESMA) released a statement on temporary product intervention measures placed on CFD trading – a raft of measures that we believe are sensible.
However,flaws in the detail could lead to unintended negative consequences.The intention is to protect unwary and inappropriate consumers from taking on risks they don’t understand and suffering disproportionate financial losses. This is a laudable intention in anyone’s book and responsible CFD providers will already be compliant with much of the detail in these recommendations.
ESMA measures include putting a leverage limit on the opening of a CFD. This level varies according to the volatility of the underlying instrument, from as little as 2:1 for cryptocurrencies to 30:1 for major currency pairs. They also include a margin closeout rule of 50 per cent of the initial required margin, meaning the position must be closed as it moves against the client.
Very sensibly, negative balance protection is mandated, which prevents a client from losing more than their deposit – this is already a common aspect of dealing with most reputable providers.
This all seems very sensible, doesn’t it? So, where is the issue? Well, there are two interlinked issues here.
What makes the CFD a popular way of trading the financial markets and hedging out other risks is the leverage it offers - the ability to take a relatively large financial position with a smaller amount of upfront margin.
Coupled with the risk mitigation measures already offered by reputable providers in the industry, or now mandated by ESMA going forward, clients should be free to use appropriate levels of leverage commensurate with their knowledge and experience.
An important consideration in setting leverage rates is consumers’ appetite for risk. This desire, if not met within ESMA’s new measures, could result in greater use of CFD products that do not come under the jurisdiction of the EU regulators, resulting in risker and more damaging trading and the likelihood of losing your money is 100%.
So, what is the answer? We believe a mix of the above, with the best outcome for the consumer at the heart of all changes; regulations that allow and encourage compliant CFD providers to offer consumers what they seek, while presenting them with risk mitigation tools and targeted education to allow them to go on enjoying the trading experience in a controlled environment – while understanding the likelihood of ultimate financial success.
ESMA should consider the imposition of leverage restrictions not as a standalone, but in the context of the other protections in place.