knowledge 28 March 2018 |

ESMA adopts Product Intervention Measures for Binary Options and CFDs

Once adopted and in force, the Measures will apply to any person marketing, distributing or selling CFDs or binary options to retail investors in the EU that requires an authorisation to do so under the MiFID II regime, including investment firms and banks. They will apply for three months, at which point they may be renewed.

Pursuant to the Measures, it will no longer be possible to market, distribute or sell binary options to retail investors.  Restrictions will also be imposed on the types of CFDs offered to retail investors and the way they are marketed, distributed or sold to such investors.  

ESMA is adopting the Measures pursuant to its product intervention powers under Article 40 of the Markets in Financial Instruments Regulation 600/2014.  They follow on from a call for evidence published by ESMA on 18 January 2018.

ESMA has also published Frequently Asked Questions (“FAQs”) in relation to the Measures (here).

Binary Options

The Measures apply to binary options comprising any cash settled derivative in which the payment at close out or expiry of a predetermined fixed monetary amount or zero depends on whether one or more specified events in relation to the underlying occur at, or prior to, such close out or expiry (e.g. the underlying has reached a specified price).

ESMA has imposed a temporary ban on the marketing, distribution or sale of such binary options to retail investors to address the high risks that ESMA perceives to be associated with them and its view that they do not meet any genuine investment needs for retail investors. The ban applies to all binary options, regardless of whether they are traded OTC or on a trading venue and expressly encompasses those that have several different predetermined conditions to payment and securitised binary options.

Contracts for Difference (CFDs)

The CFDs that are in scope of the Measures encompass any derivative other than an option, future, swap or forward rate agreement, the purpose of which is to give the holder a long or short exposure to fluctuations in the price, level or value of an underlying, irrespective of whether it is traded on a trading venue, and that must be settled in cash or may be settled in cash at the option of one of the parties other than by reason of default or other termination event.  According to the FAQs rolling spot forex contracts are CFDs for the purpose of the Measures. However, ESMA has confirmed that warrants and turbo certificates are not in scope, notwithstanding the similarity between them and the in scope CFDs. It has also confirmed that the securitisation of in scope CFDs does not take them out of scope.  

ESMA has imposed the following restrictions on the marketing, distribution or sale of CFDs to retail investors to address ESMA’s view that they are complex and inappropriate for the large majority of retail investors.  Such marketing, distribution and sale will only be permitted where each of the following protections is provided:

Leverage Limits: CFDs must be subject to leverage limits on the opening of a position by a retail client meaning that CFD providers will have to require retail investors to pay a certain amount of initial margin (encompassing any payment for the purpose of entering into the CFD, excluding commission, transaction fees and other related costs) on the opening of a CFD.  The leverage limits vary according to the volatility of the underlying and are as follows:

• 30:1 for major currency pairs;
• 20:1 for non-major currency pairs, gold and major indices;
• 10:1 for commodities other than gold and non-major equity indices;
• 5:1 for individual equities and other reference values;
• 2:1 for cryptocurrencies - ESMA has indicated that it intends to monitor the market for financial instruments providing exposure to cryptocurrencies closely and assess whether stricter measures are required.

A margin close out rule on a per account basis: this will standardise the point at which CFD providers are required to close out a retail investor’s CFD(s), on the terms most favourable to the retail investor, being when the aggregate of the funds in the CFD trading account and unrealised net profits of all open CFDs on that account falls below 50% of the total initial margin protection for those open CFDs.  ESMA has confirmed that a CFD provider may instead impose a margin close out rule on a per position basis at 50% of the initial margin requirement for the specific position.

Negative balance protection on a per account basis: this limits a retail investor’s aggregate liability for all CFDs connected to a CFD account with a CFD provider to the funds in that CFD account (including net profits from the closure of CFDs accrued but not yet credited to the account).  If financial instruments other than CFDs are credited to the same account as CFDs, the retail investor’s liability is limited to the funds explicitly dedicated to trading CFDs, only.  

Restriction on the incentives offered to trade CFDs: CFD provides will be prohibited from providing retail investors with any payment or benefit in relation to the marketing, distribution or sale of a CFD, other than the realised profits of any CFD provided; and

Risk warning: CFD providers will have to include an appropriate risk warning in any communication to, or information made accessible by, a retail client relating to the marketing, distribution or sale of a CFD. Such risk warning must include the percentage of the CFD provider’s  retail investor CFD trading accounts that lost money over the last 12-month period (such calculation to be performed quarterly on a preceding 12 month basis).  The Measures prescribe the methodology for calculating such loss.

Next Steps

ESMA intends to translate the Measures into all of the EU’s official languages in the coming weeks after which they will be adopted and published in the EU’s Official Journal.  The prohibition on the sale of binary options to retail investors will start to apply one month after publication and the restrictions applicable to CFDs will apply two months after publication. As indicated above, the Measures will apply for three months, at which point they may be renewed.

The Central Bank has welcomed ESMA's Measures and issued a warning to consumers against binary options.