2018 will be an extremely important year for retail brokerage in the European market. ESMA’s intervention regarding derivative financial instruments such as contracts for difference and binary options comes with regulations that will likely have a significant impact on the European brokerage industry in the coming years. For many brokerage companies, these changes present enormous challenges, but strong companies may have an advantage in this situation. The following analysis presents the cost of the regulations, their possible impact on the OTC market, and their impact on XTB itself.

What is ESMA?

The European Securities and Markets Authority (ESMA) is an institution of the European Union that aims to protect investors and ensure the integrity, stability, and proper functioning of financial markets. Since the OTC (over the counter) market is an area receiving increasing attention from consumers of retail financial services, the European regulator’s interest in stricter supervision and regulation of this market appears quite natural. ESMA regulations must be applied in every market of the Union and are therefore of major importance for the XTB group. We remind you that our group has a local market presence in countries such as the Czech Republic, France, Germany, Poland, Portugal, Slovakia, Spain, and Romania.

What do the new regulations target?

 ESMA has decided to use the new mechanism called “product intervention”, which aims to protect retail investors. The most important aspects of these new regulations are expressed mostly in terms of leverage limits, although the document itself is much broader:

1. The intervention introduces a ban on binary options, instruments that have been classified as too risky for retail investors. XTB management considers this change to be of secondary importance for the company, given the limited addressable market for these instruments and their low share of total group turnover.
2. Another series of changes concerns contracts for difference (CFDs), an important product in our offering. Maximum financial leverage has been limited to 30:1, but for many traders this limitation will be more severe, falling as low as 2:1. The upper leverage limit of 30:1 has been set for major currency pairs, 20:1 for other currency pairs, gold, and major equity indices, 10:1 for other equity indices and other commodities, 5:1 for other unspecified instruments, and 2:1 for CFDs based on virtual currencies. A study conducted by the Comparic portal shows that over 90% of traders oppose such severe limitations. ESMA stated that it received 18.500 responses to its public consultation invitation, most of them from individual investors and traders. This suggests that the changes are not necessarily welcome among trading communities and will not be to their liking. These changes will require higher deposited amounts to maintain a given market exposure, which is costly because funds blocked in this way could be invested profitably elsewhere. XTB sees these changes as radical and potentially counterproductive. If traders choose to leave the EU jurisdiction in search of improved trading conditions, they will no longer benefit from European protection.
3. There will be an account-level margin close-out rule that will trigger the closing of positions with a negative balance if the margin level falls below 50% of the original value at account level. XTB considers this level feasible.
4. Product intervention introduces mandatory negative balance protection. This means that a retail trader’s loss cannot, under any circumstances, exceed the account balance. The authority wants to provide additional protection to retail traders, helping avoid situations similar to 2015, when the Swiss National Bank abandoned the support threshold for the Swiss franc, triggering shock waves across global currency markets. The XTB Group fully supports this measure; in fact, XTB had already implemented this practice before it was addressed by ESMA.
5. The regulations also limit a series of incentives that may be offered in relation to CFD transactions. XTB approves this principle, although company management still sees certain benefits in the existence of some form of incentives for strengthening a long-term relationship between a broker and its clients.
6. Finally, the European authority introduces intervention to standardize risk warnings, a measure XTB fully approves because it ensures greater transparency and increases awareness among consumers of retail financial services regarding the high risk associated with investing in leveraged derivative financial instruments.

Is it worth remaining a client of a European broker?

In short: yes, definitely. Although CFD trading with brokers in Europe will require larger deposits, traders should prioritize their safety above all.

XTB emphasizes that some brokers offering potentially attractive trading conditions are either unregulated or regulated in obscure, distant jurisdictions, and therefore clients’ money may be exposed to high counterparty risk. In addition, even if a broker has a license, the large distance and differences in regulatory and supervisory environments may make it almost impossible for clients to exercise their rights. Moreover, traders should note that in no country outside the EU are they offered negative balance protection.

At the same time, XTB highlights the issue of unregulated brokers, or brokers operating at the edge of the law, that offer their services in Europe from outside it. Many of these companies use aggressive marketing and sales techniques, presenting a vision of quick profits while, in reality, encouraging clients to take excessive risks. These companies have a negative impact on the integrity of financial markets in Europe, and their activities should be examined by ESMA.

Make sure you carefully check the broker’s license

It is clear that investing through a trusted and regulated broker should be a priority for every trader. XTB always recommends checking the license not only on the company’s website, but also on the website of a regulatory authority. In addition, investors can make sure that a brokerage house is not included on public warning lists. Traders should be aware that different licenses offer different levels of security for clients. Some offshore licenses may offer less protection than licenses from European Union countries.

Higher leverage for professional traders

It is worth remembering that the limits introduced through ESMA regulations refer to retail clients. Clients of brokerage houses, including XTB, may consider becoming professional traders, provided they meet the criteria imposed by the European authority. ESMA itself emphasized this possibility in its statements:

“If you want to continue trading CFDs without the leverage limits introduced through product intervention, or if you want to continue trading binary options, you can speak with your broker, carefully considering reclassification as a professional trader.” – ESMA Q&A, questions related to product intervention

It should be noted that certain conditions must be met in order to become a professional trader. More specifically, the client must cumulatively meet 2 of the following 3 conditions:

1. The client has executed, on average, at least 10 transactions in the last 4 quarters, with a nominal value of at least 50.000 euros.
2. The client holds a total portfolio of financial instruments and cash holdings of at least 500.000 euros
3. The client has at least one year of professional experience in the financial sector, in a position requiring knowledge of financial markets

ESMA reminds that although professional clients will not have leverage restrictions, they will have to give up a certain degree of protection offered to retail clients.

How will ESMA regulations affect XTB?

Our company is prepared for a temporary decrease in traded volumes, but we are convinced of the business’s viability over the longer term. First, clients will adjust their trading strategies over time. Second, XTB expects the European market to consolidate. ESMA regulations may make this business less attractive to companies seeking quick profits and lacking a stable client base. Companies with a generous offering of financial instruments and strong diversification could benefit from this process and increase their market share. XTB management sees these opportunities and has ambitious objectives in this regard.

The biggest change for both traders and the brokerage business in Europe is the limitation of leverage for retail clients. Traders will need to deposit larger amounts for each transaction and, as a result, revise their trading methods. When it comes to the OTC market in Europe, this could mark the beginning of market consolidation, where companies with a well-diversified business, both geographically and by product, such as XTB, have the greatest chance of withstanding it. – Omar Arnaout, CEO of XTB

We offer more than CFD instruments — XTB is reintroducing traditional stocks and ETFs to its offer

XTB considers it necessary to offer investors and traders a broad range of investment opportunities, all accessible through a single trading platform. Such a solution provides not only convenience, but also efficient use of capital. Investors do not need to transfer money from one account to another in order to trade stocks, ETFs, or derivative financial instruments. With this in mind, XTB has reintroduced stocks from 16 major global markets to its offer, alongside ETFs or CFDs. These markets include NYSE, NASDAQ, LSE, Deutsche Borse, and many others. This will allow investors to create balanced, well-diversified portfolios. We must emphasize that these are traditional stocks and traditional ETFs, not CFD-type derivative instruments. XTB management is convinced that such a broad offer, accompanied by cutting-edge technology, is the future of trading and investing.

We offer our clients over 1500 stocks listed on 16 major exchanges. In addition, we have introduced ETFs and will give clients access to over 200 funds. These allow investors to implement numerous strategies using a single integrated trading platform. As a result, trading costs and execution time will be considerably reduced. – Omar Arnaout, CEO of XTB

Trading derivative financial instruments is risky. Losses may exceed the blocked margin.