Shearman & Sterling LLP | FinReg | European Securities and Markets Authority Confirms Product Intervention for Contracts for Difference and Binary Options
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  • European Securities and Markets Authority Confirms Product Intervention for Contracts for Difference and Binary Options
    The European Securities and Markets Authority has confirmed that it will use its product intervention powers under the Markets in Financial Instruments Regulation to prohibit the marketing, distribution and sale of binary options to retail investors. It will also impose a number of restrictions on the marketing, distribution and sale of Contracts for Difference to retail investors. Both CFDs and binary options have given rise to significant investor protection concerns, due to their complexity, the lack of transparent information at the point of sale, the risk of significant loss for investors and the deployment of aggressive marketing techniques by providers and distributors of the products.

    Under MiFIR, ESMA has the power to impose temporary prohibitions or restrictions on certain financial instruments, financial activities or practices when, among other conditions, the exercise of ESMA’s power addresses a significant investor protection concern in the Union. ESMA can exercise its power for renewable temporary periods of up to three months.

    ESMA issued a statement in December 2017, which announced that supervisory convergence work and measures imposed by national regulators in this area had not been enough to control or reduce investor protection concerns. This was followed by a call for evidence in January 2018 on the possible use of its product intervention powers.

    ESMA has considered the responses to the call for evidence, which closed on February 5, 2018, and is proceeding with a complete ban in relation to binary options. ESMA is of the view that any restrictions other than a prohibition would be insufficient to address the significant investor protection concerns that arise from inherent features in these products, such as the very short duration of binary options contracts and their pricing structure.

    ESMA is also proceeding with restrictions on the marketing, distribution and sale of CFDs. The restrictions consist of leverage limits on opening positions, a margin close-out rule that is applicable on a per account basis, a negative balance protection on a per account basis, preventing the use of incentives by a CFD provider, and a firm-specific risk warning delivered in a standardized way.

    CFDs that will be subject to the restrictions are any derivative other than an option, future, swap or forward rate agreement, the purpose of which is to give the holder a long or short exposure to fluctuations in the price, level or value of an underlying, irrespective of whether they are traded on a trading venue. The restriction only applies to cash-settled CFDs (or those which may be settled in cash at the option of one of the parties other than by reason of default or other termination event). ESMA has confirmed that warrants and turbo certificates are not in scope, despite their similarities with CFDs. Conversely, securitized derivatives that are CFDs would be in scope were any to be issued (ESMA is not currently aware of any). As regards CFDs with cryptocurrencies as an underlying, ESMA has agreed on a 2:1 leverage limit on the opening of such a CFD. However, due to the specific characteristics of cryptocurrencies as an asset class, the market for financial instruments providing exposure to cryptocurrencies–such as CFDs–will be closely monitored and ESMA will assess whether stricter measures are required.

    ESMA plans to translate the product intervention measures into the official languages of the EU, following which it will publish an official notice on its website. The measures will then be published in the Official Journal of the EU.

    The prohibition on marketing, distribution and sale of binary options will take effect after publication in the Official Journal. The restrictions on the marketing, distribution and sale of CFDs will take effect two months after their publication in the Official Journal. The measures will each have an initial duration of three months, after which the measures may be renewed.

    The U.K. Financial Conduct Authority has issued a statement welcoming the measures by ESMA and announcing that it expects to consult on whether to apply these measures on a permanent basis in the U.K. to firms offering CFDs and binary options to retail clients.

    View the ESMA announcement.

    View ESMA Q&A accompanying the announcement.

    View the FCA statement.

    View the ESMA call for evidence.