The end of CFDs and Binary Options? – Why the EU has put a stop & what comes next

The writing has been on the wall: times for CFDs and Binary Options are getting more difficult with the latest announcements from the European financial watchdog, ESMA (European Securities and Markets Authority) to ban the marketing, distribution and sale to retail investors. Does this CFD ban and prohibition of Binary Options mark the end of the road for these instruments in Europe?

The firms offering CFDs and Binary Options saw it coming: when ESMA announced in December last year that it was considering a crack down, the share price in providers of CFD and Binary Options platforms fell sharply. In the New Year a number of these firms then told the FCA, the British regulator, that they intended to stop providing CFDs to firms that distribute their products on an advisory or discretionary basis. When the regulator than pondered a move against CFDs and cryptocurrency derivatives and launched a consultation later in January, no one in the sector could ignore anymore that hard times would lay ahead. The announcement by Google to update its financial services policy  to restrict the advertisement of CFDs, rolling spot forex, and financial spread betting, was just the icing on top of the cake for the critics of these products.

And now, ESMA has formally adopted what it had already announced at the end of March: a restriction on the marketing, distribution or sale of CFDs to retail investors and an outright prohibition of such activities for Binary Options. These measures apply from 2 July 2018 for binary options and from 1 August 2018 for CFDs.

The Q&As ESMA has published together with the announcement regarding the adoption of the ban provide some clarity on a number of open questions. For example, ESMA makes it clear that firms are not required to apply the product intervention measures to CFDs sold to retail clients prior 1 August. ESMA also highlights that “in relation to CFDs, firms are required to apply the margin close-out protection and the negative balance protection under Article 1(e) and 1(f) of Decision 2018/796 to new CFD positions when the measures come into effect. Firms may choose to create separate sub-accounts for CFD positions opened prior to the implementation date. Alternatively, firms may choose to extend the margin close-out protection and the negative balance protection to existing CFD positions. Firms should inform clients of the changes in the terms and conditions of their account in a durable medium in good time before the changes apply. Firms exercising their discretion to close retail clients’ open CFD and binary option positions, other than in accordance with existing terms and conditions, prior the measures coming into effect without the express consent of their retail clients will not be considered as acting in the best interests of the client as required under Article 24 of MiFID II”. The Q&As also bring clarity with regard to a number of other aspects such as margin close-out protection, monetary benefits, aggregate liability, or guaranteed stop loss orders.

The document also touches on the definition of binary options, in particular whether it is limited to instruments with only two outcomes. ESMA states that the prohibition applies to binary options when the payment is limited to a predetermined fixed amount or zero if the underlying of the derivative meets one or more predetermined conditions, and vice versa and provides an example that aims to makes it easier to understand:

“In addition to the contracts described in the recitals of the BO Decision, this includes contracts in which payment is contingent on multiple events occurring. For example, a contract in which the client receives a EUR 2,000 payout for a EUR 500 investment (premium) if the DAX30 reaches 12,035, the USD/EUR pair 0.8235, and Brent Crude reaches USD 70.40.

This also includes contracts in which the payment to the client increases if certain events occur. For example, it includes a contract according to which the holder receives a payout of EUR 600 if the USD/EUR pair reaches 0.8235 plus an additional payout (bonus) of EUR 200 if the USD/EUR pair reaches 0.8300. In other words, the holder receives a total payout of EUR 600 if the USD/EUR pair reaches 0.8235 but not 0.8300, and a total payout of EUR 800 if the USD/EUR pair reaches 0.8300.”

While the Q&As provide some needed explanation of details, it doesn’t influence the planning of CFD and Binary Options platforms. The announcement in March and last week were just the logical consequence of a process that started with an ESMA statement little less than a year ago where it referred to the work of its CFD Task Force that goes back even further and was established in July 2015. The regulator had been concerned about the provision of speculative products such as CFDs, rolling spot forex and binary options to retail investors for a considerable period of time. It therefore conducted ongoing monitoring and supervisory convergence work in this area for more than 2 years, but the outcome was that ESMA remained concerned that these supervisory convergence tools were not sufficiently effective to ensure that the risks to consumer protection are controlled or reduced that would satisfy the financial watchdog.

Nor is it the end of all woes for CFDs and Binary Option providers. For instance, the Norwegian regulator Finanstilsynet followed suit by adopting the ESMA measures and the trend is clear. In the United States CFD’s were already off limits and only a few jurisdictions remain where it CFDs can still be offered.

Does this mean the end for CFDs and Binary Options in the EU though? ESMA has made it clear that following this temporary intervention, which is limited to measures on a three monthly basis, it will review these and consider the need to extend them for a further three months.