When the European Securities and Markets Authority (ESMA) came into force on August 1, it signaled widespread changes and restrictions on retail electronic trading. It impacts how certain leveraged financial instruments, such as CFDs, can be offered by brokers and traded by retail investors.
The restrictions impose leverage limits on CFD trading opening positions. The leverage boundaries on CFD opening positions by a retail client vary from 30:1 to 2:1, depending on how volatile the underlying trade is.
The most notable limits are:
Further restrictions include:
How have retail brokers made their way through the new rules and kept their heads above water? The immediate survival strategy has involved recruiting traders from non-ESMA-affected markets and disabling advertising to IP addresses and networks in Europe, then redirecting them to other markets.
These are not small measures, so it’s fair to ask how trading volumes have been affected and perhaps even more justified to assume that the answer is negative. Of most interest, of course, is the EUR/USD pair.
The markets’ response
Contrary to expectations and despite wide-ranging surveys, the clear verdict is that the implementation of ESMA has not had much of an impact on trading volumes. In fact, the day after ESMA kicked off, August 2, 2018, saw trading volumes up to and including 4pm London time spiking. This could perhaps be explained by noting that there are many regions of the world in which this kind of regulation is also present in forex markets. The biggest concentrations of retail forex trading can be found in Cyprus, the United Kingdom, Australia, North America, Hong Kong, Singapore and Japan. Japan can be used as an obvious yardstick given the similar trading environment when it comes to trading infrastructure, regulations and more.
Japan’s industry is focused on its domestic market, even though it accounts for between 35% and 40% of the world’s retail forex volumes. In early 2013, the Japanese FSA imposed leverage restrictions on all Japanese market participants. In a further equivalent scenario to ESMA, many global firms have attempted to enter the Japanese market by partnering with local firms, trying to carry out direct deals with Japan or some variation of the two. To date, no one has attained success.
The patriotic Japanese
Surprisingly, despite the presence of international competition, forex and CFD trades in Japan are more voluminous than ever. Japanese traders don’t seem to be looking to trade with overseas firms, either. There were fears that the domestic domination of the market would come to an end as a result of the FSA rules, but business has carried on as usual.
In fact, Japan’s domestic market has such a voracious appetite that its own firms have pulled out of overseas markets. The net effect was to increase the amount of margin that traders had to place, which only strengthened the assets that brokerages were managing. From this, we can predict what might happen in Europe as it, too, is highly regulated with a robust domestic forex population. The one obvious difference is that European brokers do not seek to serve only local brokers. Take the example of Cyprus, the brokerage capital: not only do they rarely serve local clients, but they don’t serve a lot of European clients, either. Many Cypriot firms are headquartered outside of Europe.
It is likely that the volume stability is due to these brokers with European clients serving clients outside of Europe, minimizing the impact of local restrictions. Most of these clients are in south-east Asia, the Middle East and Russia.