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Binary options and financial trading: could regulatory warnings lead to clampdown?
Binary options sites have been heavily criticised in the press and by regulators recently. Does this portend tougher marketing and licensing regulations and could leveraged products also be included in any regulatory clampdown?
By Scott Longley
The consumer-facing financial trading sector – or more precisely the binary options part of it – has been generating seriously critical press attention and regulatory heat of late. In the UK the government is yet to decide whether the activity should fall into the ambit of the UK Gambling Commission or the Financial Conduct Authority (FCA), the financial watchdog.
The likelihood is that the FCA will be tasked with regulating it, but sources in the UK financial trading sector suggest any final decision to shift regulator will probably wait until the implementation of MiFID II (Market in Financial Instruments Directive) in January 2018.
However, the regulatory limbo didn’t stop the FCA stepping in to issue a warning in July about the risk posed by fraudulent firms operating in the binary options space.
Later that month the European Securities and Markets Authority (ESMA) issued a more general notice about speculative products being offered to retail investors, including Contracts for Difference (CFDs) and binary options, highlighting how they were being offered to consumers who were unaware of the inherent risks of highly-leveraged trading products.
Steven Maijoor, chairman at ESMA, said firms were selling financial trading products to “people who didn’t understand them”.
“These products are often advertised to the retail mass-market via online platforms and sold without investment advice,” he said.
“When these products are marketed and sold in an aggressive manner or when firms otherwise fail to comply with their regulatory obligations, this creates the conditions for retail investors to suffer significant detriment, including unexpected losses.”
Ad restrictions and regulatory clampdown
Further, ESMA highlighted actions taken by the regulator in Cyprus, the Cyprus Securities and Exchange Commission or CySec, to impose over €2m of fines and settlements with eight firms based out of Cyprus: Depaho, Reliantco, IronFX Global, WGM Services, Pegase Capital, Rodeler, Banc de Binary and Ouroboros Derivatives Trading – and which trade throughout Europe under the rules of MiFID, or the Market in Financial Instruments Directive. Of these, Pegase Capital has also had its CySec license rescinded.
Subsequently, the financial regulator in the Netherlands has announced it is banning the advertising of binary options on similar grounds, saying that it is protecting consumers against “harmful investments”.
The chairman of the Dutch financial regulator Merel van Vroonhoven reprised the FCA and ESMA comments when he said the ads for binary options offerings “lure consumers with the prospect of earning quick money, but the reality is that you can easily lose your entire investment”.
Such developments shouldn’t surprise anyone involved in or who has been following the binary options vertical for any length of time.
The Times has run highly critical investigations into the selling practices of binary operators in the UK and in markets such as France, current affairs TV programmes have shown hidden camera investigations recording highly damaging conversations of executives running binary options operations.
The footage portrayed those companies as ‘boiler room’ sales set ups, recruiting customers by being highly aggressive and letting them win a couple of times before getting them to deposit and lose significant amounts of money.
Analysts at Morgan Stanley admitted in a note from mid-October on the prospects for UK-listed retail financial trading firm CMC Markets that the regulatory environment for the that sector was “looking less favourable”.
The analysts noted that along with the news from ESMA and the Netherlands, Belgium has moved to ban retail financial trading products entirely, the French have, like the Dutch, moved against the marketing of such products to consumers.
“Consumer protection is a growing concern for regulators, particularly as complaints have increased and poor practices have been uncovered in the retail CFD and spread-betting industry,” said the Morgan Stanley team.
Leveraged products and costly repositioning
The analysts said the likeliest moves would revolve around marketing, where there were clearly worries over the appropriateness and suitability of the product for mass consumers.
However, they added that there was also a small chance that regulators might move against business models that allowed for leverage.
“There is a chance that regulators could favour business models whereby customers cannot lose more than their deposit, as opposed to players such as IG and CMC, where customers are exposed to the risk of negative balances,” they added.
The UK FCA in February this year warned the major UK-based CFD providers on issues surrounding appropriateness assessments as well as issues around anti-money laundering procedures.
The so-called ‘Dear CEO’ letter came a year after the CFD provider Plus500 was pulled up by the FCA over just this issue. In the ensuing washback an opportunistic bid from Playtech was lodged and then withdrawn.
The Morgan Stanley team pointed out in the note that Playtech has been busily repositioning its Markets.com offering to comply with already tighter regulatory standards.
This has included eliminating introductory brokers and moving towards a more automated sales funnel with stricter onboarding (customer recruitment) procedures and greater restrictions on marketing and promotions.
The analysts point out this has already had an effect on the business with new customer sign-ups at Markets.com falling circa 45% in the first half of the year, active customers on the site falling by 11% and revenues for the financials business in total down year-on-year by 31% to €28.7m in the six months to June.
Nevertheless, the Morgan Stanley team remained relatively positive on the prospects for Playtech’s financials arm, saying the recent “realignment” of the business leaves it well-positioned to grow in a “more balanced manner” and with a lower regulatory risk exposure.
But they did caution that should that regulatory backdrop worsen, there could be significant downside given that circa 60% of Markets.com revenues emanate from Europe.
The risks cannot be dismissed easily. As mentioned, the Sunday Times has been running a series of exposés that point to the roguish behaviour of some in the binary world and in a report in September it suggested the UK Gambling Commission chairperson Sarah Harrison had been in meetings with both the FCA and the police about plans to crackdown on the sector.
The industry will have to wait and see whether this meeting portends anything more serious than regulatory moves related to merely the marketing of these products.