European regulator cracks down on 'risky' products aimed at retail investors

Regulators have had binary options and CfDs in their sights for a while

ESMA said it was imposing restrictions partly because CfDs and binary options are too complex (Getty/iStock)

The European Securities and Markets Authority (ESMA) has announced plans to crack down on “risky” products being sold to retail investors.

The watchdog will ban binary options, and restrict the marketing, distribution or sale of contracts for difference (CfDs).

Binary options enable investors to get a predetermined, fixed pay-out if an underlying asset meets certain agreed conditions, usually if a price meets a specific level, generally within a particular time-frame. CfDs enable investors to speculate on the rise or fall of the price, level or value of an underlying asset. They are typically offered with leverage, meaning investors are required to put down only a portion of the investment’s total value. However, financing and transaction costs are usually based on the total value of the investment.

According to ESMA, the ban is being introduced because there is a “significant investor protection concern in relation to CFDs and binary options offered to retail investors... due to their complexity and lack of transparency”.

Research by the European watchdog, conducted along with member states’ domestic regulators, into CfD trading across the EU shows that between 74 and 89 per cent of retail accounts “typically lose money on their investments”. Analysis of binary options “also found consistent losses on retail clients’ accounts”.

ESMA chair Steven Maijoor said: “The new measures on CFDs will for the first time ensure that investors cannot lose more money than they put in, restrict the use of leverage and incentives, and provide risk warning for investors. For binary options, the prohibition we are announcing is needed to protect investors due to the products’ characteristics.

“The combination of the promise of high returns, easy-to-trade digital platforms, in an environment of historical low interest rates has created an offer that appeals to retail investors. However, the inherent complexity of the products and their excessive leverage – in the case of CFDs – has resulted in significant losses for retail investors.”

Mr Maijoor added that a pan-EU approach is required because of the cross-border nature of the products in question, and said: “ESMA’s intervention is the most appropriate and efficient tool to address this major investor protection issue.”

Regulators across the EU, including the UK’s Financial Conduct Authority (FCA), have been heading towards heavier controls on these products, usually sold by spreadbetting firms, since 2016.

When the FCA first announced it was looking into restricting the sale of CfDs, shares in spreadbetters IG Group, Plus 500 and CMC Markets tumbled dramatically.

On Tuesday, IG and CMC were both down, but Plus 500’s stock rose almost 4 per cent in morning trading.

EU regulations state that ESMA can only introduce temporary intervention measures on a three monthly basis, so the regulator will need to consider whether to extend the restrictions beyond the first three month period.