The European Securities Markets Authority is out with its verdict on the leverage restrictions for the industry. Despite feedback from clients and brokers, the supranational European regulator chose to limit the choices for leverage for retail brokers.

The ESMA’s decision is to prohibit marketing, distribution, and sale of binary options and introduce tiered leverage for different instruments. Any Contracts for Differences (CFDs) that are allowed on offer will need to adhere to strict requirements and are temporarily restricted to a set of draconian rules.

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Tiered leverage

The leverage restrictions for retail clients will be introduced in several tiers. CFDs on major FX pairs will be traded with 30:1, indices, non-major currency pairs and gold will be traded at 20:1, while other commodities and non-major indices will be provided with a 10:1 gearing. Brokers will be able to offer individual equities at a 5:1 leverage and cryptocurrencies at 2:1.

As expected brokers will also need to provide negative balance protection and close out margin positions whenever the account reaches 50 percent of the minimum required margin. Bonuses and any form of incentives are also prohibited, while brokers also need to develop a standardized risk warning which displays what percentage of clients loses money.

Terms of the restrictions

The ESMA intends to adopt the new restrictions on Binary and CFDs shortly after the publication of its March 23 decision. The measures will be rolled out in the official languages of the EU in the coming weeks, following which the supranational regulator will publish an official notice on its website.

The procedure dictates that the measures will then be published in the Official Journal of the EU. Official implementation of the binary options ban is expected within a month after that, while the restrictions on CFDs will have to be implemented two months after their publication in the EU’s Official Journal.

According to MiFIR regulations, the ESMA can only introduce such intervention measures on a temporary basis for three months. The regulator is expected to publish those before the end of the three months and will be considering the need for an extension every three months after that.

ESMA Chairman elaborates

According to the official announcement, the ESMA’s decision was driven by the desire to secure retail investor protection. The use of excessive leverage and binary options are considered by the EU-wide watchdog as products that have a structuraly expected negative return.

Commenting on the regulatory move of the ESMA, the regulator’s Chair, said: “the agreed measures ESMA is announcing today will guarantee greater investor protection across the EU by ensuring a common minimum level of protection for retail investors. 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. A pan-EU approach is required given the cross-border nature of these products,  and ESMA’s intervention is the most appropriate and efficient tool to address this major investor protection issue,” Majoor elaborates