Spread betting firm IG Group Holdings PLC (LON:IGG) has received a deluge of applications from private investors looking to get around new regulations.
The firm said it has received around 15,000 applications from clients electing to be treated as “professional investors” since November, ahead of new regulations to be introduced by the European Securities and Markets Authority (ESMA).
READ: IG Group sees 10% revenue drop from new margin trading regulations
Those regulations are designed to protect ordinary “retail investors” - i.e. Joe and Josie Public - who may be dabbling in highly leveraged trades in their spare time.
According to the rules, in order to qualify as a “professional client”, a customer must meet two of the following three criteria:
(a) the client has carried out transactions, in significant size, on the relevant market at an average frequency of 10 per quarter over the previous four quarters;
(b) the size of the client's financial instrument portfolio, defined as including cash deposits and financial instruments, exceeds €500,000;
(c) the client works or has worked in the financial sector for at least one year in a professional position, which requires knowledge of the transactions or services envisaged
IG said more than three-quarters of the applications received to date have been rejected but nonetheless it now has 3,800 clients that are categorised as professional.
Furthermore, clients categorised as professional contributed more than 35% of IG's UK and EU over the counter leveraged revenue in the last three months, and the group continues to expect this proportion to rise to 50% when the ESMA measures come into effect.
Protecting retail investors from getting in over their heads
On March 27 of this year, ESMA introduced new restrictions on the provision of contracts for differences (CFDs) and binary options to retail investors in the European Union (EU).
A CFD is a way of betting on the movement in the value of something – a stock market index, an exchange rate, a share or, theoretically at least, the amount of rainfall experienced in the month of May in Greater Manchester.
The bigger the movement, the larger the reward or loss – and there's the rub; unlike regular gambling, the size of the possible loss or gain is not known at the time the bet is placed.
Binary options are, if anything, even scarier. According to Investopedia, a binary option is structured to be either a fixed amount of compensation if the option expires in the money (hooray! You win), or nothing at all if the option expires out of the money (boo! Sell the car).
Binary option trades typically run for short time periods, generally varying between 30 seconds and five minutes, giving the addicted punter the same sort of adrenaline rush that is apparently delivered by the fixed odds betting terminals, also known as “the crack cocaine of gambling”, that are prevalent in betting shops.
A binary option in some ways is as simple as betting on the outcome of a boxing match or whether the UK will win the Eurovision Song Contest (it won't).
For example, a punter might bet that the sterling exchange rate will fall below U$1.3330 in the next five minutes.
Where the analogy with the bet on a sporting event breaks down is the possibility of the company that sold the punter the binary option trading in the market – e.g. buying US$10mln worth of sterling on the foreign exchange markets – in order to influence the outcome.
Of course, the same “dodge” is open to the punter that bought the binary option but the individual punter tends not to have the same clout in the market as the big trading platform operators.
As ESMA put it in its consultation document: “In most cases, the firm you are buying options from benefits when you lose. This places the firm’s interest in direct conflict with yours, which increases the risk of poor conduct by firms offering these products.”
Leaving aside the speculation that the spread betting firms might be betting against their own punters, there is definitely a risk that a client could quickly get in over his or her head.
As it succinctly says on the IG web site: All trading involves risk. Losses can exceed deposits.
What are the rules being introduced by ESMA?
Consequently, ESMA decided it ought to introduce a number of restrictions, namely:
1. Leverage limits on the opening of a position by a retail client that vary from 30:1 for major currency pairs, such as “cable” - the dollar/sterling exchange rate – to 2:1 for crypto-currencies.
With a leverage ratio of 30, an individual who has deposited £5,000 with a spread betting firm can see the position move against him to the tune of £150,000 (£5,000 x 30) before being asked to stump up more money (“a margin call”);
2. A margin close-out rule on an account-by-account basis. This will standardise the percentage of margin (at 50% of minimum required margin) at which providers are required to close-out one or more retail client’s open CFDs;
3. The introduction of an overall guaranteed limit on retail client losses;
4. A restriction on the incentives offered to trade CFDs;
5. A standardised risk warning, including the percentage of losses on a CFD provider’s retail investor accounts.
Research by national regulators across different EU jurisdictions found that 74-89% of retail accounts typically lose money on their investments, with average losses ranging from €1,600 to €29,000.
Any analysis of human nature suggests that most retail investors opening account think they will be among the 11-26% that make money from trading in highly leveraged instruments; holding that belief is, literally, against the odds, which is why the authorities have moved to protect punters from themselves.