Risk Warning: Your capital is at risk. Statistically, only 11-25% of traders gain profit when trading Forex and CFDs. The remaining 74-89% of customers lose their investment. Invest in capital that is willing to expose such risks.

ESMA Finally Puts Its Foot Down On MiFID II Regulations

Author: Martin Moni
Martin Moni
All publications of the author

Changes to FX regulation in Europe had been looming for over a year ever since the final draft of MiFID II was tabled by ESMA. The new rules came in place from the 1st of August, and they have been considered draconian by many traders and brokers alike. In case you’re wondering why we waited so long to discuss this, it’s because we wanted to see how the new rules were affecting the industry. By the end of this article, you should be able to determine whether ESMA’s actions have been beneficial or otherwise to the consumers and even the FX trading brokers.

How did the new regulations come to be?

The main regulatory framework for EU financial markets is usually decided upon by the European Parliament and then enforced by ESMA. These regulations are all included in one piece of legislation known as MiFID. The second version of these legislations, MiFID II was discussed from 2011 and was first published in 2014. Over the following years, ESMA was taking suggestions and responses from the participants of the financial markets in order to achieve the most ideal version. Contrary to the US where legislation is passed by congress alone, the EU takes a more interactive approach to ensure fairness. This is why lobbying efforts in the US have such a huge sway on the legislations there. By including responses from those who will be affected by the laws, the EU achieves fair but effective laws. (You should be aware of the upcoming: Changes In FX Regulation Through MiFID II)

Anyway, following the release of the first draft of MiFID II, ESMA took several years to implement the new laws, which first came into action in 2018. Soon after their implementation, the European parliament immediately noticed some issues with the laws. The main problem, as the experts saw it, was the reporting of trades as required by MiFID II. Furthermore, many market participants were still clearly not clear on what the new laws required. Due to this and the fear of penalties for failure to comply, there were pleas of a repeal. Further down the line as the months passed, another piece of legislation, GDPR was also passed that seemed to conflict with MiFID II. For example, MiFID II required that financial companies, including brokers, report their clients’ trades and keep records while GDPR allowed individuals to have their data deleted whenever they willed it to be. (GDPR Is Finally Here! All You Need To Know And How It Affects You)

To address some of the problems experienced by companies in the EU, cover new regulations and further refine MiFID II, ESMA released its final report of guidelines in May 2018. This is where we are now in terms of regulation, and there seems to be no appeals in the horizon. Moreover, these same laws also apply in the UK because it is still a part of the EU until the Brexit talks are finalized. The implementation of these new laws in the EU is bound to change the face of the FX market for years to come, which is why it is such an important subject to look at. (Find out: How the Brexit affected FX trading)

What do the new regulations entail?

Most of the changes in FX regulations had already been covered in the first rollout of MiFID II, and there have only been additions in the areas of leverage and binary options. Nevertheless, these have been so severe to send shockwaves around the financial markets worldwide. (Revealing FX Bonuses Of Brokers: How To Identify A Real Bonus)

Cap on leverage

In the initial drafts of MiFID II, there was a call to limit leverage down to 50:1 from the astronomical amounts of leverage available that could often be as high as 1000:1. The idea here was to protect traders from too much risk without their knowing. Many people who first begin trading the FX market go for the highest leverage possible, and this is why research shows that 40% of new traders quit within the first month, probably because they lost all their money. It is only until a trader proves himself that the broker was supposed to increase their leverage, but even then not going higher than 200:1. Even with this initially proposed cap on leverage, there was a bit of uproar from traders and brokers alike, but it was still better than in other restrictive regions. In the US, for example, leverage is capped at 50:1 on major currency pairs and 20:1 for exotic pairs. Japan is even stricter with a cap on leverage at 25:1. (FX Rigging And Manipulation: How The Major Investors Pull It Off)

However, ESMA now wants to join the ranks of Japan by placing a cap on leverage at 30:1 for all major currency pairs. With exotic pairs, major indices and gold, the cap would be placed at 20:1 while other commodities other than gold, other indices but the major ones would be traded with a 10:1 leverage. Finally, cryptocurrencies’ leverage would be limited to 2:1. This is probably the worst blow since cryptocurrencies have become a major selling point for FX brokers as they try to attract more clients to sign up. Regardless, ESMA believes that cryptocurrencies are just too volatile to have any significant leverage, hence the high cap on leverage. (If you want to choose, as yourself: Should You Invest In CFDs Or Stocks To Make More Money?)

As you can expect, many people are outraged at this cap on leverage, but unfortunately there is no recourse but to comply. In the coming sections, we shall see how various market participants have been dealing with these sudden and drastic changes that some are now labelling draconian. (Do you know: How Is Spread Betting Different From FX Trading?)

Ban on binary options

The debate on binary options is not new, but this time ESMA decided to just end the debate once and for all by completely banning the industry. For years there have been complaints by clients who have lost all their money, and regulators have had a very hard time taming the industry. Various proposals had been considered by many regulators, but it just didn’t seem to be viable. CySEC, for example, have been considering regulating the binary options industry themselves, although the final decision has still not been reached. As for ESMA, they have declared that enough is enough and there is no other way to revive the tainted industry. All marketing, distribution and trade of binary options is hereafter banned in the EU, unless you want to use an offshore broker. There are several options for this, but it is probably a good idea to learn from ESMA and see the dead industry for what it is. (Do you ever ask yourself: Can A FX Broker Avoid Sending Trades Directly To The Interbank Market?)

How has the FX market reacted to the new rules?

If you are a trader based in the EU or EEA, you will probably find these new regulations very tough. You are not alone, because they are indeed very restrictive, even more than those seen in the US where we typically considered to be a tough environment. Even the brokers will definitely be affected, so it would be interesting to see how the interests of both brokers and clients could realign. (Is It Time To Upgrade To Metatrader 5: Features Of MT5)

For clients, what does this mean?

The retail FX market has been around for decades and open to the public. The only problem was that, to participate required a lot of capital. As you may know, the minimum quantity you need to transact in any FX trade is one lot, which represents 100,000 units. This means that, to buy the GBP/USD pair, you need to buy 100,000 units of the sterling pound. This requires £100,000 or about $127,000 going by the current exchange rate at the time of publishing. Obviously, this is a huge amount of money to commit into one trade, and thus the FX market was only the privy of the rich and investment firms with big bucks. Nevertheless, things changed after the internet became commonplace because now anyone could have access to the markets and FX brokers saw an opportunity. By providing FX trading platforms to each of their clients and enough leverage, anyone could afford a taste of the markets. (Concepts Every Trader Should Understand: Leverage, Margin And Hedging)

It started off slowly, but soon leverage could be as high as 1000:1 or even more as competition among the brokers became higher. This would mean that to buy one lot of the GBP/USD pair, you would only need £100 or about $127. Moreover, leverage could also increase the potential profits because even minor changes in the exchange rate could result in magnified gains. Now the question was no longer about whether one could have access to the FX markets but rather choosing a FX broker with the best trading conditions, chief among them leverage. (For better results, learn these: Ichimoku trading techniques)

However, now the amount of leverage has been limited to just 30:1, and that goes for major currency pairs while exotic pairs and CFDs have even lower leverage. Therefore, the same allure retail FX trading had just a few years ago is gone, which would mean that less individuals would be willing to trade the FX market. But the story may be more complicated than that, since these new rules apply only to brokers in the EU. If you have been a former trader working with an EU-based broker, then you probably received an email from them notifying you of the new changes. Your broker may also have advised you that you had the option to shift to a different version of their company/website. (We have been wondering: What Is The Future Of Cryptocurrency In Finance?)

Many FX brokers nowadays have numerous branches around the world to cater to clients in different locales. For example, a broker may have an EU-branch for European clients, an Australian branch for Australian clients, etc. Therefore, by switching to a different branch of the same company, you would avoid ESMA’s tough regulations while still retaining your favourite broker. Alternatively, if your EU-regulated broker doesn’t offer such an option, it is still possible to find another broker. Finance Magnates had an interview with the head of marketing for ADS Securities, a FX broker regulated by DMCC in the UAE. In the interview, he admitted that since the new regulations were implemented, the brokerage has seen an increase in clients from the European region. This tells us that many clients of EU-regulated brokers may be looking for greener pastures elsewhere. (Do you know: What Is The Financial Commission And Can It Be Trusted?)

Is this the right thing to do?

Inasmuch as you may want to dump your EU-regulated broker for one based offshore, it may be prudent to really think about it beforehand. First, high leverage is never such a good idea unless you really know what you are doing. Even though we have mentioned this before, perhaps it needs repeating as many people still lose money this way. Say, for example, you’re buying one lot of the EUR/USD with a 1000:1 leverage and a $500 margin, each pip would be worth $10. This means that your entire margin could be eaten up if the trade went against you by just 50 pips, which is not too difficult especially if there is an important event on the FX calendar. This is why ESMA sought to reduce leverage, in order to protect clients from losing all their money. (To succeed, find out: How Not To Be Added To The 95% Of Losing Traders)

Second, and probably most important is that EU FX regulators are one of the most trusted in the world. By opting for an offshore broker, you could be setting yourself up for failure if you happen to work with a scam broker. (These are: The 3 Most Trusted Exchange Authorities in The World)

All the same, the new regulations may be just too much for most traders, and there is perhaps no way to make them work under those conditions. The only warning we can give is that you ought to be careful about where you decide to take your money because there are a lot of jackals out there who are just waiting to take advantage of the situation. (Lessons on self-defence: FX scams)

And in case you’re residing in the UK and imagine you’re safe from these new regulations, think again. Despite the Brexit vote and the ongoing negotiations between the UK and the EU, the UK is still technically part of the EU until the process is finalized. This means that the FCA will adopt the changes proposed by ESMA as if it were still in the EU and FCA-regulated FX brokers will have to apply them too. UK residents working with such brokers will have to hope the Brexit process is concluded swiftly, one way or another, and then wait for the FCA to repeal these changes. Suffice it to say, it may be a long wait. (Aren’t you tired of this: Let's get on with the Brexit already!)

What does the research show?

As it turns out, it’s not just mere speculation about the positive effects of lower leverage, and there is actual data to back it up from research on Capital.com accounts. Even though ESMA rules were to come into effect in August, Capital.com provided them 2 months earlier on the 1st of June 2018 as a choice. Users who signed up could work with the normal leverage or opt for the anticipated ESMA-limited leverage levels. Apparently, many of the new and existing clients chose the lower leverage proposed by ESMA. Guess what happened? Losses were significantly reduced and chances of receiving a margin calls as well. (Learn: How to protect yourself from margin call)

According to the research, the size of the average loss fell by 80% when traders opted for the lower leverage as compared to the prior loss size. The frequency of getting margin calls also dropped drastically. Before the new regulations, traders had a 30% chance of receiving a margin call within the first 15 days of trading, but this fell to just 5% chances. According to the CEO of Capital.com, the new rules were, instead of hurting the industry, going to strengthen it further and encourage growth. He predicted that there would be growth in the industry because traders would not be losing as much money as they did before. Now, focus would be placed more on education rather than advertising as many brokers used to do before in order to lure in new traders with the high amounts of leverage. Whether this will become true we can’t yet say for sure, but there is some merit to it. In recent years, the fastest growing brokers were those who could sign up as many clients as possible just by using catchy sales pitches. (Investing In Cryptocurrencies: Watch These 5 Profitable Cryptocurrencies)

What about the FX brokers?

Clients aren’t the only ones who have been dealt a heavy blow by ESMA as they too were against such measures. Prior to the implementation of these rules, many brokers had sent petitions to ESMA and the FCA not to enact such draconian laws, but apparently they weren’t listened to. Perhaps this is exactly what the major FX brokers were hoping for, since they disliked the competition, but we’re just speculating here. It would make sense, though, for the older, well-established companies not to stop ESMA’s actions hoping that the newer firms would be squeezed out. This is because the older firms have more institutional clients and do not rely so much on retail clients. (Do you know: Which Are The Most Influential Cryptocurrency Markets By Country?)

As it turns out, this is exactly what has been happening since the 1st of August and even before that. As soon as ESMA published the new regulatory framework to be implemented from the 1st of August, many EU-regulated brokers expressed their interest in moving offshore. This is not impossible to foresee since it has happened in the past. Following the Dodd-Frank Act of 2011 in the US, most FX brokers left the continent to focus on the European market due to unfavourable conditions. Considering that the conditions by ESMA are even tougher than those by the NFA, it is very likely there may be a mass movement of brokers offshore. (You should be aware of the: Laws and limits of FX trading in the US)

This does not mean that there will no longer be brokers in the UK, far from it. After all, London is the hub of the FX market. Fortunately, unlike the US there are still some caveats to the regulations by ESMA. The most critical one is that the new laws will only apply to retail clients, but professional traders are exempt. This could allow FX brokers to classify some of their clients as professional traders and thus exempt from the leverage restrictions. (Ask yourself: Does BTC Stand A Chance To Becoming The Worldwide currency?)

So how do you become classified as a professional client and not a retail one? Simply apply. In interviews with several brokers, Finance Magnates found that several brokers were reviewing requests by clients to be classified as Elective Professional Clients (EPCs). But do not expect to become one simply because you applied. There is also a test you have to pass to demonstrate your skills as a trader that determines how good you are at trading. As you can already see, there are some opportunities for brokers to classify more of their clients as EPCs. Remember, though, that the brokers are only doing this because they admit they need to offset the potential losses they may suffer if clients suddenly move to offshore brokers. However, if you are a high-value client with consistently positive results, that EPC classification may be around the corner. (Here are the: 5 tips to forming the most promising cryptocurrency investment portfolio for 2018)

There is one final advantage the brokers have, and that is because they don’t rely too heavily on retail traders for their revenue. For example, Plus500 revealed that they got 75% of their revenue from just 12% of their traders. IG Group noted that 3,800 clients generated 35% of their revenue while OctaFX got 80% of their revenue from 20% of their clients. In general, it would seem there is a 90/10 rule in the industry, where brokers get most of their revenue from only a handful of clients. This is some consolation to the brokers because they can be confident not to go under simply because retail clients choose to leave. In fact, they can now focus on satisfying the needs of the institutional investors and reduce running costs associated with dealing with numerous retail clients. It may be a sad fact, but it is fact all the same – the top ECN FX brokers don’t really need the retail client. (These are the: Top 10 Most Outrageous FX Market Scammers)

What does all of this mean?

In the end, the FX industry will continue to be the largest financial market in the world. While the enactment of these new tough regulations may be a hurdle in the road for it, it is not enough to stop the massive $5.1 trillion industry. To get the exact numbers and effect of the regulations by ESMA, we shall have to wait for the Bank for International Settlements (BIS) to release its report next year. Most likely, there will be a decrease in trading activity in Europe through 2018, but we doubt if there will be a notable difference in the total amount of volume traded. (Do you know: How much money FX brokers make?)

For now, given that there may actually be some advantages to using the limited leverage, it may be a good idea to keep playing it safe and retain the services of a trusted EU-regulated broker. For those who still want to enjoy high leverage, perhaps because of limited capital, then you have plenty of other options. ASIC regulated FX brokers would be the best bet, or you can go for riskier alternatives. Whatever you go for, remember to stay safe – it’s a jungle out there!


Most of all, the new regulations are going to affect you, so why not recap what we’ve seen about the impact of these regulations:

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Risk Warning: Your capital is at risk. Statistically, only 11-25% of traders gain profit when trading Forex and CFDs. The remaining 74-89% of customers lose their investment. Invest in capital that is willing to expose such risks.
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