Germany takes steps to ban retail trading in financial CFD instruments

Do not invest more money than you can afford to lose.

Germany’s Federal Financial Supervisory Authority (BaFin) intends to limit the marketing, distribution of and trading in financial contracts for difference (CFDs) as a measure to protect retail investors. Contracts with an additional payments obligation, such as margin, will soon not be available to retail clients.

BaFin published on Thursday a draft General Administrative Act concerning the issue. Once the rules are approved, they will come into effect within three months of that date.

“In the case of CFDs with an additional payments obligation, the risk of loss for the investor is incalculable. For consumer protection reasons, we cannot accept that”, said BaFin head Elisabeth Roegele.

According to the regulator, leveraged trading is, in economic terms, a form of speculation on credit. Financial CFDs with an additional payment obligation may result in price gaps and often require investors to pay more than they have initially invested. The difference to be paid can amount to multiples of the margin they have put down. Protection tools, such as stop-loss orders and margin call, are not effective in limiting client losses. In fact, they could lead to increases losses since investors’ positions could be forcibly closed at highly unfavorable prices.

As a result, the regulator is considering it is best to ban financial CFD trading altogether. The regulator noted that CFDs have an advantage over direct investments, but CFD providers target almost exclusively retail clients, the draft project read. Various studies have shown that the majority of active CFD traders lose their money.

The regulator lists several main risks associates with CFD trading – the complexity of performance calculation, speculation on credit, lack of transparency in the calculation of underlyings where there are price gaps, no limitation on the risk of loss through the margin call procedure, and no limitation of the risk of loss by stop-loss orders, among others.

In the case of CFDs, leverage quickly results in losing control over market developments and makes it all but impossible for an average retail investor to anticipate the likelihood of losses and, consequently, chances of success, BaFin’s draft project read. For each CFD position, the investor only has to put down a fraction of the contract value as a margin on their CFD trading account and are herefore exposed to the financial consequences of the speculation with an investment amount, of which they actually only have to put up a small percentage themselves.

In CFD trading, investors trade on the price movements on underlying financial instruments, rather than buying the instruments themselves. They make profit from the difference between the buy and sell prices. The German legislators treat CFDs as a subgroup of derivatives.

Earlier this year, The Times of Israel cited BaFin press officer Anja Schuchhardt as saying the Germany regulator was considering to possibly impose a ban on trading in binary options and contracts for difference (CFDs). No details were available at the time. In addition, Die Welt cited Roegele as saying that prohibition of margin trading and binary options in the country is possible due to their dangerous nature.

Europe eyes stricter financial markets regulation

In the last few months, financial trading markets have been the target of the authorities of a number of countries, mainly in Europe. Just this month, the Cyprus Securities and Exchange Commission (CySEC) and the Financial Conduct Authority (FCA), the two leading forex regulatory destinations in Europe, announced they are to alter the standards for key forex trading conditions. Both authorities are setting a new leverage cap of 50:1 (25:1 for inexperienced traders with less than 12 months of trading under the UK framework). They are both banning bonuses or other benefits to promote risky trading instruments. While the new requirements set by the CySEC sounds rather recommendation, the UK watchdog uses a more compulsory tone. The changes were triggered by the recommendations and guidelines of the European Securities and Markets Authority (ESMA) from mid-October in regards to forex and binary options regulation.

Earlier this year, several financial watchdogs also launched an attack against binary options. Belgium banned from 18 August the distribution via online channels of over-the-counter (OTC) binary options, spot forex, and CFDs with leverage. France also banned recently the online advertising of “highly speculative and risky financial contracts”, such as binary options, forex and CFDs with a leverage greater than 1:5. Meanwhile, the Netherlands has also announced that it considers ban on the advertising of such instruments, calling them “toxic investment products for consumers”.

Israel, which is not an EU member state, also imposed a ban on trading in binary option instruments in the country. Recently, the Israeli regulator also said it is to ban the advertising of binaries to retail clients abroad, which would put an end to major brokers will not be able to operate locally-based call centers.