It was the early Christmas present nobody in the City’s booming spread-betting industry wanted.
The European Securities and Markets Association (ESMA), a European financial regulator, said late on Friday that it was considering banning the sale of so-called ‘binary’ options to retail investors.
It may also impose restrictions on the sale of ‘contracts for difference’, a popular trading instrument that enables investors to track the performance of an underlying asset – such as a stock, an index, or a commodity such as gold or oil – without actually owning that asset.
Shares of all of the big spread-betting firms have today fallen on the news, with IG Group, the market leader, dropping by as much as 15% at one point, while CMC Markets and Plus 500 fell by as much as 19% apiece.
There will not be too much quarrelling with the proposed clampdown on binary options. These, as the name suggests, are win-lose bets where a punter gambles on an outcome – for instance whether the FTSE-100 will rise or fall – over a set time period that can be as short as 30 seconds and is generally no longer than five minutes.
They are seen as exceptionally risky and the Financial Conduct Authority, the chief City regulator, has warned that the majority of people betting on them lose money.
The FCA, which will take over regulating the sector from the Gambling Commission in January next year, also believes binary options are rife with fraud. It said last month that, since 2012, there have been a reported 2,605 victims who have lost £59.4m on binary options scams. A number of countries, including Canada and Israel, have already banned binary options outright.
The proposed clampdown on CFDs is more contentious.
What ESMA is considering doing is to impose so-called ‘leverage limits’ on investors. At present, depending on the creditworthiness of the customer, the firm selling a CFD will allow an investor to use leverage in which the investor places a trade but with an initial outlay that is only a fraction of the actual contract.
For example, a leverage ratio of 10:1 would mean that although a customer appears to be investing only £1, they are in fact investing £10. So leverage allows gains and losses on CFDs to be multiplied. Get it right and you win spectacularly. Get it wrong and you are on the hook for more than your original stake.
What ESMA is considering is “leverage limits on the opening of a position between 30:1 and 5:1, whose limit will vary according to the volatility of the underlying asset”.
It is also considering what is known as a ‘margin close-out’, which would mean that a client’s position is closed when they run short of margin, a sum deposited with the provider of the CFD in order to place the trade and to keep the position open. A margin close-out would effectively limit the downside to an investor.
The leverage limits under proposal are far more aggressive than those in the United States which, in October 2011, capped leverage limits at 50:1. Most of the proposed range would also be more strict than in Japan where, again in 2011, the cap on leverage limits came down from 50:1 to 25:1.
IG Group said today: “The leverage restrictions under review are disproportionate and go beyond what is needed to protect consumers from poor outcomes associated with excessive leverage.
“The danger of disproportionate leverage restrictions on regulated firms is the risk that they will push retail clients to trade CFDs with unregulated firms based outside the EU, potentially resulting in poor client outcomes.”
It also insisted that, because a growing proportion of its customer base are “of high value and sophistication”, it has less to lose from the clampdown than many of its rivals. IG stopped offering binary options to new clients earlier this year and the product accounts for less than 5% of its business.
CMC said much the same, while in its response, Plus 500 stressed it does not even offer binary options.
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Some people may regard ESMA’s proposed leverage limits as a tad aggressive, particularly compared with the US and Japan, the two markets most comparable with Europe.
Binary options, though, have led to a lot of human misery. Few would mourn if they were no longer made available to all but professional traders.