Europe-wide ban on ‘risky’ binary options

In brief…

On 27 March 2018, the European Securities and MarketsAuthority (ESMA) announced a ban on the marketing,distribution and sale of binary options to retail investors.ESMA also announced that it will require a mandatory riskwarning for all Contracts for Difference (CFDs) sold toretail investors. This represents the first use of ESMA’sproduct banning powers under article 40 of the Markets inFinancial Instruments Regulation.

On 24 August 2018, ESMA followed up its decision byrenewing the three-month ban from 2 October 2018 butexcluding two low risk binary options. ESMA concludedthat the renewal of the prohibition was necessary, giventhat the offer of binary options to retail clients continues toraise important concerns in terms of investor protection.

ESMA said that it was concerned with how these inherentlyhigh-risk speculative products are offered to retail investors.Binary options allow an investor to ‘win’ a lump sum of cash ifthe value of an agreed underlying asset is above a certainprice when the option expires. CFDs allow an investor to beton the underlying price movement of an asset withoutactually having to own it. Because they are leveragedcontracts, the amount the investor may lose if the asset valuegoes against the bet is of a much greater magnitude.

‘The combination of the promise of high returns, easy-to-trade digital platforms, in an environment of historical lowinterest rates has created an offer that appeals to retailinvestors. However, the inherent complexity of theproducts and their excessive leverage – in the case ofCFDs – has resulted in significant losses for retail investors’,ESMA said.

Ban on binary options

The prohibition on the marketing, distribution or sale ofbinary options to retail investors began on 2 July 2018 andwas set to last for three months. The restriction on themarketing, distribution or sale of identified CFDs to retailinvestors commenced on 1 August 2018 and was also setto last for three months.

The Financial Conduct Authority (FCA), which isempowered to enforce the ban in the UK, welcomed theEU-wide temporary product intervention measures andplans to consult on whether these measures should be putin place on a permanent basis. The ban on marketingbinary options extended to social media as well as the useof sponsorships such as in sport.

The renewed ban commences on 2 October 2018 forboth binary options and CFDs and will last forthree months from that date. Excluded from therenewed prohibition are the following products:

1. A binary option for which the lower of the two predetermined fixed amounts is at least equal to the total payment made by a retail client for the binary option, including any commissions, transaction fees and other related costs, and
   
   
2. Binary options that satisfy cumulatively the following criteria:
   
   
• The term from issuance to maturity is at least 90 calendar days
• A prospectus drawn up and approved in accordance with the Prospectus Directive is available to the public, and
• The binary option does not expose the provider to market risk throughout the terms of the binary option and the provider or any of its group entities do not make a profit or loss from the binary option, other than previously disclosed commissions, transaction fees or other related charges

The measures announced by ESMA will apply only to retailclients. Binary options may still be marketed, distributed andsold to so-called professional clients, including those clientswho elect to be classified as professional. In its FrequentlyAsked Questions, ESMA has warned retail investors toconsider very carefully whether they should adoptprofessional client status and lose the extra regulatoryprotections afforded to retail clients.

Concerns remain about non EU-based binary optionsfirms offering binary options to European retail investors.In the minutes of ESMA’s Securities and MarketsStakeholder Group meeting on 8 February 2018, ESMAChairman Steven Maijoor noted that ESMA would also beable to address offers coming from outside the EU by useof the product intervention powers.

Mandatory requirements on CFDs

ESMA’s use of its product intervention powers for CFDsconsist of mandated:

• Leverage limits on the opening of a position by a retail client from 30:1 to 2:1
• A margin close-out rule of 50 percent on a per account basis
• Negative balance protection on a per account basis
• A restriction on the incentives offered to trade CFDs, and
• A standardized risk warning, including the percentage of losses on a CFD provider’s retail investor accounts

This mandatory warning and percentage figures of investorlosses are expected to boost transparency in the CFDindustry and give retail investors pause before investing inCFDs. IG Group Holdings Plc (IG), an operator of anonline trading platform offering CFDs, stated that it wasdisappointed that ESMA has chosen to proceed with itsproposal to ‘impose disproportionate leverage restrictionswhich will unduly restrict consumer choice, and riskpushing retail clients to providers based outside of the EUor to use other products which allow the leverage clientsseek’. IG also noted that ESMA announcement relates onlyto retail clients. IG’s client base is predominantlysophisticated traders. IG believes that clients categorizedas elective professional generate over half its UK and EUrevenue. The measures imposed by ESMA will not apply tothese professional clients.