Why CFD traders are likely to jump to unregulated brokers

The restrictions implemented by the European Securities and Markets Authority (ESMA) on August 1, 2018, may be detrimental to the trading industry and the providers involved. The regulations have limited the advertising and sale of contracts for difference (CFDs) provided to retail traders. In particular, trading CFDs on forex currency pairs has seen a limit in leverage of 30:1 on major forex pairs and 20:1 on minor forex pairs. Both margin and negative balance protection are also now determined for each client individually based on their account. Incentives are no longer permitted, and all CFD brokers are obligated to disclose a standard risk warning of the volume of losses their clients incur. This is one way of helping to separate the trading world from its current stereotypical association with gambling.

The implications of this regulation

After introducing these changes in June, Capital.com has seen a reduction in the number of clients who reach a margin call while using a lower leverage. The amount dropped from 30% of the clients to 5%, with the size of the losses also decreasing by more than 80%.

Some brokers might feel relieved by this positive outcome, but others are not as welcoming. XTB CEO Omar Arnaout fears losing clients as a result of the regulation. He has publicly warned traders to “be aware that different licenses provide different levels of security for investors.” He also mentions that the limits on leverage may put European traders off and lead them to opt for non-EU brokers who aren’t affected by the changes. As far-reaching as the impact may be, change takes time. Once the benefits become evident, it will be easier for the market to adapt.

Client reactions

These regulations are aimed at the marketing, distribution and selling of CFD products to retail investors, but they do not apply to professional clients. Many unhappy retail traders have decided to apply for professional trading status, which occurred before the regulations were officially implemented. A spokesperson for the IG Group made it clear that this process is not that simple; more than 75% of the applicants are being rejected.

Those at Hantec Markets have noticed the same surge in professional status applicants since the announcement of the new rules. Both providers, along with many others, feel that crucial CFD advice right now is that traders should not make this decision lightly because it results in the loss of a vast amount of protection provided to retail traders.

Potential moves

Although there is likely to be a significant decrease in trade volume from European traders, a spokesperson for FXCM believes traders shouldn’t forget that when compared to futures contracts, spot forex and CFD trading offer a vast amount of benefits. FXCM also feels that the previous rules and those outside of Europe are more reasonable and that the market would benefit if the restrictions were eventually pushed back again. Saxo Bank’s Kim Fournais agrees that these changes could steer traders in the direction of unlicensed and unregulated European brokers. However, this remains a matter to be handled by the relevant authorities.

The regulations are still being reviewed as the changes take effect in the market. Because the rules are generally implemented during a period of six to nine months when related to CFDs, the final review might be extended to the end of October. After this date, it will be confirmed whether the ESMA regulations will remain or if the limits will return to their previous amounts.

Ultimately, the changes aim to create a more secure trading environment with a higher standard. If everything goes according to plan, this will improve the conditions of the industry in the long run. However, the possibility still exists that clients will not be willing to adjust and will turn to alternative trading providers, which holds its own amount of risks to the industry.