European regulators last night revealed plans to outlaw one of the most popular trading products available to the public.
The European Securities and Markets Authority (ESMA) wants to ban the sale of binary options to retail clients.
The prohibition is part of a wider clampdown on the spread betting sector that would also see contracts for differences leverage (CFD) limits – the amount of risk/reward a retail investor can expose themselves to – dramatically reduced.
One year ago, City watchdog the Financial Conduct Authority (FCA), surprised the spread betting sector by unveiling its own plans to protect retail investors. A number of other European regulators followed suit and during this summer the matter was passed onto ESMA, so changes could be imposed Europe-wide.
ESMA said it will conduct "a brief public consultation in January 2018" on its plans. Once put in place, it would be the first time ESMA has used so-called "intervention powers" in financial markets.
The changes may come as a blow to some spread betting firms, which have booked bumper profits during 2017. Others, of which CMC Markets has been very vocal on several occasions, believe the clampdown will help business by forcing rivals that focus on "lower-value" customers out of business.
What is the difference between binaries and CFD?
Binaries and CFD have a number of similar traits and are often available on the same underlying assets.
A binary is effectively a yes-no bet on a specific outcome – this means investors either lose all their money or make a certain return.
CFD work differently by mirroring the returns of an underlying asset, meaning investors can win or lose part of their initial stake. But CFD investors can also win or lose more than their initial stake by leveraging their investment so it is more than their initial stake.
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Last December's FCA plans did not reference binary options contracts because at the time they were regulated not by the financial watchdog, but by Britain's gambling regulator, the Gambling Commission.
At the time the FCA wanted to reduce CFD leverage limits to a maximum of 25:1 for new customers and 50:1 for experienced ones.
But last night, ESMA took a slightly different approach, saying CFD leverage limits should be capped much lower – between 30:1 and 5:1 depending on the volatility of the asset invested in.
Similar to the FCA proposals, ESMA wants to restrict trading bonus' and incentives, as well as standardising risk warnings.