This article was written by Craig Paton, CEO of CraigPatonCapital LTD.
The European Securities and Markets Authority (ESMA) on the provision of contracts for differences (CFDs) to retail investors in the European Union (EU). The most notable change is , 500:1 to 30:1 and even lower for different asset classes. So what does this really mean for retail brokers? Let’s dive into it.
Cutting the business model by over 400%
If you are going to cut a business model by over 400% what implications will that have for the future business? When a retail client opens a trading account they will be placed onto 30:1 leverage with a required stop out
margin level of 50%. Meaning that one standard lot of EUR/USD will require roughly $3,000 in margin, and if their margin level falls below 50% they will automatically be stopped out.
Here’s something else: when you are reaching your stop out level, the broker will cut half or a quarter of your position for you to stay in your trade (profit already secured for the broker) which takes you back above the required percentage for you to stay in your losing trade. They will repeat this until you have no capital left.
The attitude towards the new situation varies according to the brokers’ business model:
and just make the spread off the client.
Leverage and margin
We have established that the business model of a retail broker will be impacted massively on two parts, leverage and margin. How will brokers counteract this crippling affect to their business?
First of all, they will put clients under different , such as the Central Bank of Bahrain or Securities Commission of the Bahamas, places where there are no restrictions on what leverage can be offered to a client. With that being said, how well do you know the regulations of the CBB or SCB? Can you make a formal complaint to the financial ombudsman as easily as in the UK?
If you are an existing client with a broker, and you registered before the regulations come into affect, I would seriously urge you to check with your broker to make sure you are still under the jurisdiction that you registered for.
The implications of being moved to a different jurisdiction can include not being covered by the financial services compensation scheme which protects your funds up to a certain amount, and companies not being obligated to segregate client and company funds, so if the company goes bust you still have your funds.
Small and boutique brokers will disappear
Hopefully, we are now beginning to appreciate and understand what implications brokers are facing and the potential drop in revenues as a result of this. Brokers will do everything in their power to make sure you have the highest leverage possible – why do you think there was a petition going round the various brokers in the city to overturn this ruling? There was even talk of a new instrument being created to skirt the lines, as these new regulations only affect CFDs and binary options. Brokers coming into effect, no business would. With the crackdown on brokers where does this leave them? ? More TV adverts? More sponsorship deals? More pro clients?
If you have ever walked into a broker’s office you would have noticed that the biggest department is the marketing team. With an average client life of 60 days (more like 30) the constant need for clients and regular capital inflows does not come from the sales team, it’s marketing. Paying one person or a team of people to interact with potentially thousands through blogs, emails and posters is much more appealing than
hiring a sales executive to speak to a retail client trading a mini lot. Brokers also use IBs and affiliates, where you pay someone to introduce clients to you, and what you pay them is dependant on how much volume their clients generate.
My personal opinion regarding the new regulations is that small and boutique brokers will disappear and only the big boys of the world will be left. From the information above, if you don’t have thousands of
clients actively trading everyday you won’t be around for long.
The purpose to this article is not to tarnish brokers within the industry but merely to educate and protect retail clients from the wrongdoing brokers and what they can do to innocent retail clients. Stay sharp out there.
Be First to Comment