Binary options burst onto the financial scene around the same time as the global financial crisis was wreaking havoc on all asset classes in 2008.
Binaries allow traders to speculate on the outcome of markets in a much more simplified way compared to traditional trading. The added simplicity combined with inflated returns and fueled by ultra-volatile markets set the scene for binary options to claim a sizable chunk of the retail trading industry, albeit under a cloud of controversy.
Australia’s national regulator, The Australian Securities and Investments Commission (ASIC), alongside many others from Europe and North America are finding elements of regulatory arbitrage and malpractice in the mushrooming field of binary providers. Retail clients have been attracted by the ‘gaming’ nature of binary options which do not require a high level of technical knowledge or sophistication, yet provide instant market access akin to traditional trading.
Trial by Regulation
Due to their novelty, non-exchange binary options are not regulated directly by any regulatory agency. Regulators see the product differently depending on the region. The Cyprus Securities and Exchange Commission (CySEC) was the first EU MiFID member regulator to treat binary options as financial instruments in 2012.
In the US, binary options fall under the jurisdiction of the U.S. Commodity Futures Trading Commission (CFTC) that only regulates listed binary options such as forex, commodities and equity index binary options listed on the North American Derivatives Exchange (Nadex). In the UK and Australia, both the Financial Conduct Authority (FCA) and ASIC do not regulate binary options directly, although any firm offering financial services must have a regulatory license to operate legally.
Some binary options are listed on registered exchanges that are subject to oversight by regulators but this is only a portion (and diminishing) of the total binary options market. The majority of binary options providers offer their services exclusively online through trading platforms that do not necessarily comply with applicable regulatory requirements.
The number of binary brokers has surged in recent years across the globe with Cyprus becoming a prime location for many new binary startups, although the amount of platforms has not, i.e. brokers are operating under white-label agreements. The increase in the number of brokers has resulted in an increase in the number of complaints aimed at binary platforms and their operators. This is hardly surprising, because in a similar fashion to the FX market, operators can enter the market with minimal regulatory oversight, limited startup capital and next to nothing staff, as this is provided as part of the white-label agreement. In such lax conditions, impropriety has flourished.
How Will Zero-Fee Investment Platforms Impact Traditional Stock Brokers?Go to article >>
The CFTC and SEC have received numerous complaints of fraud associated with binary options. The complaints fall into several categories including: refusal to reimburse funds to customers; identity theft; and manipulation of software to generate losing trades. However, the malpractice is assumed to only occur at unregulated venues that are not subject to regulatory oversight and are not required to keep funds segregated in trust accounts.
In the Land down Under
According to Forex Magnates’ research, the binary options market in Australia only has a handful of regulated brokers with offices based in the country.
Probably the largest provider by volume and market capitalization is IG Markets, a UK-based company with sizable operations in Australia. The other notable regulated entities are MXT Global, (formerly known as Enfinium/Vantage FX), HighLow (operated by Realtime Capital Markets) and PowerOption (AVA Capital Markets). All offer a similar range of traded binary options including FX, commodities and equities.
Forex Magnates’ research and analysis suggest that the larger firms that tend to obtain regulatory approval before offering binary options, are currently seeing double-digit percentage growth in both live active accounts and volume traded, month-on-month. A similar trend is prevailing among unregulated providers as well, which suggests new clients do not discriminate between providers based on the presence of regulatory approval. This is despite hundreds of cases of customer complaints and regulatory action assisted by public relations campaigns to raise awareness among current and future binary options customers.
It is worth noting that all regulated Australian binary option brokers already have existing operations in FX/CFD markets and have started offering binary options as an extension of their current ASIC license. If a broker already has an ASIC license to offer margin FX trading services, they are able to offer binary options as well.
The big issue ASIC (and other regulators) have with binary options is that they are not a traditional asset class. They are essentially a betting game on the outcome of an event. The payout structure is also unlike any other financial asset. If a binary option expires ‘out-of-the-money’ the client loses 100% of his investment, but if the client’s option expires ‘in-the-money’, the client can expect to earn around 80% or less. A negative cumulative payout is achieved and the broker can expect to ‘beat’ the client the more the client plays. This has led to calls from across the financial services industry for binary options to be classified as ‘gaming’ platforms in a similar vein to sports betting. In this case, all regulatory oversight falls under the jurisdiction of the applicable Gaming Commission. In Australia, each of the country’s eight states has a separate gaming commission:
There’s very little ASIC can do to stop jackpot hunting retail traders from participating in binary options trading. Clients can open accounts outside of Australia in regions such as New Zealand or Cyprus but forego all regulatory protection. Given that most binary option buyers are retail clients on the hungrier side of the risk appetite scale, it’s highly likely that unregulated brokers from across the world will continue to tap the Australian market because of the tendency of retail clients to overlook stability in favor of profit potential. Oftentimes, retail clients are not even aware from which country their binary broker is operating from.
Financial regulators oversee finance and trading while gaming commissions oversee gambling and betting. Now that a financial instrument overlaps both sectors, the regulatory tangle couldn’t get any messier.