Reported on Thursday was a circular about fair trading practices related to binary options that was sent by CySEC to entities under its jurisdiction. The circular came days after ESMA had released an inaugural Q&A paper on how speculative products facing retail customers such as CFDs, forex and binary options fit within MiFID rules.
Part of the MiFID rules accepted by the EU and enforced by individual country regulators is the obligation of brokers to act “honestly, fairly and professionally in accordance with the best interests of its clients, to take all reasonable steps to avoid conflicts of interest, and to execute orders on terms most favorable to the client.” The Q&A covered what the fair and honest practices are that brokers should and shouldn’t be doing.
In the current circular, CySEC addresses some of the MiFID concerns of fair practice for binary option brokers with a focus on transparency. Items to be implemented include explanation of how prices of options are calculated, displaying the underlying asset that a binary option is based on and the ability to cancel orders.
Given the proximity to the ESMA Q&A, the CySEC circular was presumably prepared before the release of the ESMA paper. However, they are similar in their directives towards fair and honest practices. As such, worth watching is whether this means that CySEC will be issuing similar updates that focus on the other speculative products addressed by ESMA, namely CFDs and forex trading.
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Are dealing desks fair and honest?
One of the highlights of the ESMA Q&A was its opinion on dealing desks and whether the conflict of interest of brokers benefiting from client losses fits within MiFID rules of fair and honest practices. According to ESMA, a dealing desk does pose a conflict of interest between the broker and the client and processes need to be in place to manage this problem.
ESMA did make an exception for STP brokers that hedge client orders on a per trade basis. However, ESMA showed that it is aware of industry practices and cited that a potential conflict of interest exists when brokers use a sister group that act as their liquidity provider (LP) to customer order flow that is sent for STP. It also stated that a conflict of interest takes place when a broker’s LP compensates them based on the profit and loss of the retail order flow.
ESMA also pointed out that brokers that use asymmetric slippage, where customers never benefit from price improvement between their order being sent and the execution, but can get a worse price, is a conflict of interest problem.
With regard to outright dealing desk activities with no hedging practices, ESMA stated that such a model should be avoided: “Such a conflict of interest in all likelihood cannot be managed and should therefore be avoided, by not adopting such a business model”.
Looking ahead, with the release of the Q&A document, and CySEC already raising standards for binary options, this could all be the beginning of EU financial regulators taking a deeper approach to enforcing the fair and honest standards required by MiFID.