Leverage on the Forex market is limited. Reflections and alternatives for traders

Yesterday, European financial market supervision ESMA presented new guidelines for the Forex / CFD market and binary options. Their task is to increase the safety of investors and "civilize" this market in the European Union (we write about the changes in a separate article). Despite the actions taken by industry representatives and retail traders, which were to soften the final shape of the guidelines, the regulator decided to introduce them in a form identical to the prototype presented in December 2017.

Market reaction

Although the market has divided into two camps - supporters and opponents of changes - it is impossible to get the impression that there are more of the latter. Objectively, some of the guidelines may actually contribute to the improvement of investor safety (e.g. uniform regulations on the stop-out mechanism, protection against overdraft). On the other hand, the new regulations hit the foundation of the Forex / CFD market, which is the leverage. In the case of Poland, the reduction is from 1: 100 to 1:30 and less. So it can be said that this is not such a drastic leap. However, in the case of other EU countries, the restriction is more "shocking". So far, investors from other countries of the community could use the leverage of up to 1: 500. That's almost a 17x reduction for major currency pairs.

Chart from the last 30 days of XTB stock

Apart from traders, European brokers will also suffer from the changes, as they will certainly experience a decrease in turnover with a simultaneous increase in risk (the need to cover customer debts). How important these changes are are reflected in the share prices of large brokerage houses. At yesterday's trading session, X-Trade Brokers lost around 9%. In the case of British brokers, such as CMC Markets or IG Group, the decreases reached around 2% (smaller scale of decreases probably due to next year's Brexit)

In the long term, there is a reasonable risk that significant turnovers will occur on the Forex / CFD brokerage market. Smaller companies, which very often force greater development of the offer and competitiveness of commissions, can irreversibly disappear from the market. For some traders, trading with the left 1: 30 and smaller can suddenly stop being attractive, and for others who have a small deposit, it is impossible. This raises concerns about the condition of the brokerage market throughout the EU. Traders can run away in search of a satisfactory level of leverage beyond the jurisdiction of the community. Anyway, brokers can do the same, but in their case the process is much more complicated and expensive.

Forex Leverage> 1:30 - Alternative solutions

Increasing the margin requirements means the need to deposit more funds into the brokerage account in order to be able to engage the same share of your account in transactions of the same volume. This can also create a problem with meeting the assumptions of your investment strategy. So the question is - is there any plan B? So far it is.

Become a professional customer

ESMA has provided for the possibility of waiving the need to be subject to new guidelines. As long as we meet certain conditions. Everything is going to the so-called customer categorization.

People who meet certain criteria can become so-called professional clients. In the sense of pan-European supervision, such a client is characterized by greater risk awareness and investment experience. Therefore, it can receive a higher lever, such as 1: 500 (in the case of Poland it is not known if it will still be 1: 100).

In order to become a professional client you have to fulfill it minimum two out of three the following criteria:

• The customer has conducted significant volume transactions on the relevant market with an average frequency of 10 per quarter over the last four quarters;
• The value of the client's investment portfolio, defined as cash deposits and financial instruments, exceeds 500 000 EUR;
• The client has been working or working in the financial sector for at least one year in a position that requires knowledge about the provision of financial services or transactions.

Customer categories by of the EU MIFID directive, there are three: a retail client, a professional client, and an eligible counterparty. The assignment of a given category is determined by filling in the so-called adequacy test. Nobody specifies exactly how and by whom the information provided by the client will be verified (or whether it will be at all). Assuming we decide to take such a step, we must consider the consequences. For example, the downside is the "waiver" of protection against a negative balance. Something at the expense of something.

Escape outside the Union?

At the moment, no document specifies, nor does it require non-EU brokers to adapt to change. Anyway, even if he did, would there be any form of pressure to force them on them? Probably not. The risk lies in the agreement of national regulators from outside the Union with ESMA, but whether such cooperation will take place will depend on the country's policy in relation to the Forex / CFD market.

The situation of British brokers is also in question. Finally, BREXIT is due for next year. Will it be that, immediately after leaving the EU, brokerage houses from Citi will be able to return to offering higher leverage? At the moment, it is known that the MiFID passport for Great Britain will be valid until December 2020 year and probably it will be a time when local brokers will be able to free themselves from European guidelines. However, there is no certainty that this date will not be postponed.

It can be assumed that the brokers from Australia are already blurring (IC Markets), that is, from countries where regulations and security are at the same high level as in the Union, and thus are able to offer traders the trading conditions ESMA has just received from them.