Over the past several years, the CFD market has seen a tremendous boom, with the European market reaching a value of €1 trillion. Thanks to marketing and endorsements, more retail traders have been drawn in to learn CFDs and other markets. However, as the market continues to grow, European financial regulators have set their targets on this industry, which appears to be claiming more money than it gives away.
CFDs, or contracts for difference, depend on the differences in exchanges and are a form of derivative contracts. These trades can be aided by leverage as high as 1:400, which has allowed many trade providers to exploit clients and their funds – at least until this year. European regulators have recognized this problem and put steps in place to correct the crimes of the industry. In August 2018, new regulations were released that enforce strict policies under the Markets in Financial Instruments Directive 2018 (MiFID II). This comes after it was made clear that many traders are not skilled enough to trade CFDs successfully and that most incur losses rather than profits.
The new regulations
These regulations have been monitored by the European Securities and Markets Authority (ESMA) and will place restrictions on the amount of leverage traders are granted by their respective CFD brokers. This is because leverage – which is essentially the borrowing of capital – makes traders more susceptible to losses and failure. Each asset traded will be analyzed based on volatility, and limits are then placed at 30 times the initial trade amount. A lack of sufficient margin will also prevent clients from opening positions and will cause them to lose money they don’t have.
How the market will adapt
This change threatens to influence the market as a whole. Profits may be affected for those who monetize off spreads and commissions in areas like volume and profits. With the change, it is also very likely that smaller traders will experience harsher effects than large traders. There are two potential outcomes in this scenario. The first is for traders to increase their margin to continue with their trades, while the second is that traders might reduce their amount of trades. Naturally, certain providers and traders will look for ways to escape these new regulations.
One tactic brokers will use is to accumulate more professional traders, whose elite status can assist in dodging the new regulation. Another technique is to find an alternative to CFDs, such as futures, which are also derivatives and advertised to clients across Europe. Executive Peter Hetherington of IG, which is one of the world’s leading online brokers, believes traders will find a way to pursue their trading as before, even if that means changing their products. However, regulators are well aware of this and have advised traders to do so responsibly, especially in terms of leverage.
There is a risk that the market will move to areas where the rules are less strict, not unlike what happened in the past with traders moving to Cyprus-based brokers. These foreign providers have been warned that they should not attempt to invite clients to make this kind of move, but it is ultimately out of European regulators’ hands. These moves will most likely be pursued by the smaller traders who are now threatened by the new rules and stand less chance of success. Many traders have already announced that they plan to migrate to brokers in other jurisdictions, such as Australia. Whether or not these regulations will indeed discourage leverage and avoid losses remains to be seen. However, it’s clear that traders will find another way if necessary. The market is not under as big of a threat as some might believe. Instead, it’s changing to become safer.