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Why ESMA Regulator Bans Forex Bonuses

Author: Martin Moni
Martin Moni
All publications of the author

Remember the days when you could create a new account and immediately be credited with a gratuity just for doing so? Well, those days are now gone, at least in the EU. This is because the financial regulator in the region, the European Securities and Markets Authority (ESMA), has banned all forms of Forex gratuities. This has been a bitter pill to swallow for most, and for many reasons. If you are among those who feel like ‘the man’ is out to get you, perhaps understanding why the regulator did so might assuage your feelings. (These are: The 3 Most Trusted Exchange Authorities in The World)

When did ESMA ban Forex bonuses?

The specific changes that lead to the banning of Forex gratuities came into effect on the 30th of July 2018. However, these changes had been in the works for several years ever since ESMA decided to review Forex regulations all around. A push for tougher, more effective regulations started to come in 2011 following the 2008 financial crisis. Prior to the crisis, ESMA used MiFID regulations to oversee the FX arena, but they felt that the laws were not tough enough to prevent another financial crisis. ESMA wasn’t the only regulator that was looking to do this, because across the Atlantic, the CFTC had implemented the Dodd-Frank Act for the same reasons. (Legalization of Forex Trading in the US: Facts and Trends)

Besides the fear of letting financial institutions run riot and losing people’s money, ESMA had also noticed an increase in complaints against Forex agents and cases of fraud. Without strict regulations and oversight, a lot of brokers were straight out ripping people off; tarnishing the FX industry and the regulator alike. For example, ESMA published on their website that the number of complaints had risen from 5,152 in the first half of 2015 to 7,026 in the second half of 2016. (Ask yourself: Can You Actually Get Your Money Back From A Fraudulent Broker?)

Starting in 2011, ESMA set out to revise regulations and create MiFID II. MiFID covers all the laws governing financial markets in the EU including the FX market. By 2014, the first draft of the laws was published, but the laws would not come into effect until January 2018. In the meantime, ESMA was taking suggestions and feedback from everyone regarding the changes in order to make any changes if necessary. (These are the: Changes In Forex Regulation Through MiFID II)

MiFID II was finally implemented in January 2018 after years of consultation, but ESMA didn’t stop there. In March, the regulator then published a draft of regulations specifically targeting the Forex market. These were to come into effect on the 30th of July 2018, and they did. Among the changes to be implemented was a total ban on benefits used to incentivize trading – Forex gratuities. There was no compromise on this ban, despite pushback from FX agents and even individual traders. Enough was apparently enough, and that was the end of the common practice. (In the end: ESMA Finally Puts Its Foot Down On MiFID II Regulations)

It is easy for an individual to curse ESMA for banning what was a very beneficial advantage. For example, many brokers offered a myriad of gratuities as soon as one signed up to their services. The first gratuity one would expect to receive was the ‘no deposit gratuity’; sort of a welcome gratuity. All you needed to do was sign up and confirm your identity and voila, you had a few dollars to trade with even before you put up any of your own money. Of course, this gratuity had many conditions; it was not free money after all. Most obvious, you could not withdraw the gratuity because that would be like the brokers were shooting themselves in the foot. And the gratuity also vanished as soon as you made a withdrawal. Nevertheless, you had a right to withdraw whatever you made from the gratuity, although even here were other conditions. (Revealing Forex Gratuities Of Brokers: How To Identify A Real Gratuity)

Other gratuities would soon follow; most commonly a percentage gratuity on every deposit and some Forex companies even had loyalty gratuities for traders who made a lot of trades within a given amount of time. All of these incentives made entry into the FX arena wildly attractive, and it is not difficult to see why anyone would be eager to sign up and start trading. (These are the: Top 10 Most Outrageous Forex Market Scammers)

ESMA did not stop at banning Forex gratuities, because the regulations also covered:

  1. a limit on leverage down to a maximum of 30:1 for major currency pairs and even lower for exotic pairs and CFDs for commodities, cryptocurrencies, etc.
  2. banning any trade of binary options
  3. requiring brokers to place a standardized risk warning statement on their websites
  4. indicating the ratio of winners to losers among their clients

We shall look at some of these other measures in the coming section to get a complete view from ESMA’s perspective and their decision to ban all Forex gratuities.

Looking through ESMA’s lens

Despite how lucrative the Forex gratuities were to the individual traders, clearly ESMA didn’t see it that way. Before vilifying the regulator, it may be better to look at their actions from their perspective to see whether perhaps they had some good reasons. (In case: You Wanted To Know How Many Traders Lose, Now You Know)

Forex gratuities suckered in amateur traders

The Forex market had become the most attractive market for anyone interested in investing in financial markets. Literally, no other market could compare especially if you didn’t have a lot of capital. Compare the Forex market to, say, the stock market.

To participate in the stock market, you need to have a decent amount of capital because of the broker and transaction fee that don’t change regardless of the number of shares bought. For example, Apple shares are now selling at $170, but the fees will be the same regardless of whether you buy 1 or 100 shares. That is why it is advisable to buy blocks of shares, but that requires a decent amount of capital, as we said. Moreover, leverage is limited to a few stock exchanges, and even those only have a little amount of it like about 2:1. (Trading Stocks in Forex Brokers: Commissions, Swaps, Spreads Research)

On the other hand, the Forex market, prior to MiFID II offered leverage upwards of 200:1, sometimes going as high as 1000:1. That would mean you needed only $1 margin to buy a single stock of Apple at a 200:1 leverage instead of the whole $170.

This was all well and good until amateur traders began to see this and get attracted to the market. The Forex gratuities only exacerbated the problem because then they could imagine getting all of this free money to use and make a fortune. It wasn’t that the gratuities were bad in and of themselves, but they lured amateur, uninformed traders into the FX arena. Once the new trader had made that deposit and earned their gratuity, they would eagerly start trading without knowing all the risks involved, and that lead to many new traders losing money they didn’t have to, if only they had not been suckered in. With the illusion of free money, new traders would take unnecessary risks and avoid getting proper trading education. In the end, they would lose both their gratuity and their own money because of the thrill of trading in the FX arena.

The hope for ESMA is that, by banning all Forex gratuities, new traders won’t be incentivized into joining the Forex market. The truth is that a person is likely to be more cautious about trading when they know they are risking their own money. You are more likely to take smaller risks and learn more about the industry before you clicked away at your Forex trading platforms. This is why ESMA summarily banned all sorts of incentives that could lure in traders who weren’t ready for the risks involved. (These are the: Top 5 Forex Traders Who Became Millionaires)

The gratuities were rigged with conditions

After luring you in, you quickly realized that it was all just a bait and switch model. Most people’s idea of Forex gratuities was that it was a way to get a leg up, but like good con men most brokers had laid a trap. Consider some of the most common gratuities, like the ‘no deposit gratuities’. The first problem was that you couldn’t withdraw the gratuity, only your earnings from it. That’s a bit silly because how much money could you really make from a gratuity of about $20 even if you were the best trader? (Here are the: 10 steps of successful traders)

And once you did get the gratuity and had made, say, $20 and doubled your virtual capital, then you would be hit by the minimum withdrawal amount. Most FX agents don’t allow for withdrawals below a certain amount, and thus you would not even be able to get what you were promised despite your hard work in front of the computer. Perhaps you may think, maybe I should deposit my own money and then I could withdraw it all plus my earnings from the gratuity? That could work, but then again you would face withdrawal charges that could wipe out the entire gratuity earnings.

What about the percentage deposit gratuities, you may be wondering, aren’t those okay? Well, they are if only you know what you are doing. Imagine someone making a $500 deposit and receiving a 20% deposit gratuity. Now their account margin is $600 including the gratuity, and you could theoretically make larger trades with the higher margin. But what if you were a new trader that didn’t know how to manage the amount of risk and a week later your account is hit with a margin call followed by a stop out a day later. Here, the gratuity suckered you into taking more risk and that was your undoing. (Learn: How to protect yourself from margin call)

Okay, so maybe the loyalty bonuses, what about those? By now, you should be getting the idea – none of the bonuses were really there for you. The problem with loyalty bonuses was that they required you to trade an impossibly high number of lots before you could earn them. Unless you were using an algorithm that made hundreds of trades a day, it would be nearly impossible to reach the set target, or take you longer than the bonus was worth. (Concepts Every Trader Should Understand: Leverage, Margin And Hedging)

The brokers didn’t care because they made money on spreads regardless of whether you were winning or losing. The bonus was merely a mirage to keep you on the trading path as long as possible until you were broke. It’s not that the brokers were lying to you, but they had hid these conditions deep in the fine print such that it was easy to miss.

Once in, getting out was too difficult

Let’s say you had doubled your account using only the no deposit bonus, wouldn’t that give you a jolt of confidence? Surely if you could double $20, you could also double $1,000 or $10,000 and become a millionaire, right? Herein lays the problem, while you were trading with only the bonus, you probably went for the highest leverage and took extreme risks. Just like winning the lottery, you managed to double or even triple the small capital. You were thinking you were the best trader in the world and were ready, but you weren’t. As soon as you started trading with your own money, you couldn’t understand why there were no profits and soon thereafter the capital was all gone. (Do you know: How Is Spread Betting Different From Forex Trading?)

It becomes even more difficult to leave because you feel so confident in yourself that you start to blame the broker; they were the problem. So you do the sensible thing and look for another broker but things don’t go well either. The bonus in this case made it hard for you to leave trading and focus on learning first. This problem has affected many people who kept looking for the next easy way to make money whether it was through buying a substandard trading bot, untested algorithms, trading courses, etc. Without the bonus, though, such a problem is stopped at the root before it manifests and becomes cancerous.

What has been the impact of the ban?

It has been less than a year since the new regulations were set forth by ESMA, so it is still impossible to tell the impact of this particular law. All the same, we have already noticed that brokers have been opening satellite headquarters outside the EU to avoid these restrictive regulations however beneficial to the traders. The problem is that most amateur traders don’t realize that ESMA was truly out to protect them instead of following the illusion. The most popular destination right now is Cyprus where CySEC is yet to implement any such tough regulations. (These are the: New Forex Brokers Regulations in Russia in 2019)

Again we would like to reiterate – bonuses aren’t the problem, they just lure in unsuspecting traders with big hopes. As long as someone can understand their value without taking them as free money, they could be beneficial. ESMA just chose not to give people the chance in order to protect them. Besides, it is still entirely possible to make money even with just a little capital to begin with, and all it takes is patience.

 

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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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