CALL FOR EVIDENCE – POTENTIAL PRODUCT INTERVENTION MEASURES ON CONTRACTS FOR DIFFERENCES AND BINARY OPTIONS TO RETAIL CLIENTS

1. CALL FOR EVIDENCE – POTENTIAL PRODUCT
INTERVENTION MEASURES ON CONTRACTS FOR
DIFFERENCES AND BINARY OPTIONS TO RETAIL
CLIENTS
Dear Sir/Madam,
We are writing to you with relation to the above call for evidence.
We would like to thank you for publicly consulting suppliers and consumers on the above
intervention measures.
Secondly, we remain at your disposal to personally clarify / submit anonymised evidence to
back our suggestions / responses to your questions.
The rest of this document outlines our feedback on your measures:
1. General considerations
2. Responses to your specific questions
General Considerations
We firmly back your decision to intervene in both the binary options and CFD markets.
Consumer outcomes in both have been negative for too long, and lead to an unnecessary
erosion in consumer trust and the public standing of the retail trading industry.
● We support your generic decision to restrict the marketing, distribution or sale to retail
clients of CFDs, including rolling spot forex, but we are deeply concerned by your
proposed one-size fits all treatment of both a) retail customers (demand side) and b)
CFD providers to retail customers (supply side) which unnecessarily restricts
underlying market forces that ​further​ the outcomes you seek to achieve:
a. Demand side​: You correctly apply a distinction in the treatment of
professional and retail clients. For this very reason your one-size fits all
segmentation of the very heterogeneous nature of “retail” clientele - unfairly
affecting the livelihood of retail ​winners ​as well as our own
b. Supply side​: You apply a uniform set of measures to two fundamentally
different business models
i. CFD internalisers, whose structural conflict of interest you rightly seek
to tame, to the benefit of vulnerable retail customers
ii. Structurally aligned CFD intermediaries, who should ​NOT ​be restricted
as i) their incentives are squarely with customers and ii) they
contribute to iii) customer education and iv) reinforce market integrity
& liquidity in way that internalisers ​erode​,

2. ● We support your decision to prohibit the marketing, distribution or sale of binary
options to retail clients, and would encourage you to work with relevant regulatory
bodies to equate their treatment to gambling products based on underlyings other
than financial markets.
On account of the above reservations, we would welcome revising your approach by further
segmenting your intervention measures on account of:
1. CFD contracts cleared on MiFID Multilateral Trading Facilities
2. Retail customers with demonstrated skill in the sector, as demonstrated by either:
a. Sufficient trading experience and/or
b. Satisfactory investment performance
Furthermore, negative balance protection is a case study in moral hazard:
1. Encourages customers to take on ​more​ not ​less​ leverage
2. Imposes market risk on retail ​brokers ​who do not internalise flow ​out​ of the CFD
market, to their and consumer detriment
Our recommendation
We believe far superior long term impact, and far inferior short term negative impact would
be achieved if you regulated intervening as follows:
1. Your proposed
a. prohibitions on binary options
b. restrictions on any internalised CFDs - including CFDs on crypto-currencies,
2. Exempt from the CFD restrictions
a. Professional traders
b. Retail traders with proven trading experience, AND/​OR
c. CFDs cleared on Mifid regulated MTFs
Specific questions
A: Do you think that ESMA has adequately identified the instruments in the scope of
its possible measures (paragraphs 3 and 5 above)?
We agree with the definition of binary options as supplied on paragraph 5.
Whilst we agree with the description of the CFD instrument, we believe your description of
CFD contracts fails to capture the structurally distinct nature of CFDs traded on vs. off
venue.
1. CFDs ​cleared off MiFID MTFs​ suffer from intransparent price finding, are plagued by
conflict of interest and are therefore structurally prone to poor outcomes with
vulnerable customers.
2. Clearing CFDs on MiFID regulated MTFs ensures price convergence and market
integrity by aligning CFD price with its underlying asset. Such CFDs are completely
transparent and free from any conflict of interest - and should therefore be subject to
no, or diminished, restrictions

3. This is because brokers (as opposed to dealers, or broker-dealers) clearing contracts ​on
MTFs​:
1. Derive no economic benefit from ​losing​ customers, and thus have ​every​ incentive to
educate​ customers about the risks of leveraged trading
2. Cannot take on market risk - which negative balance protection would impose on
them
On that account, we wholeheartedly ask that you specifically differentiate between ​on
Exchange​ and ​Off Exchange​ cleared CFDs, as the former are transparent in every way
where the latter are not.
B: What impact do you consider that the introduction of leverage limits on the basis
described above (applying to retail clients only) would have on your business? Please
describe and explain any one-off or ongoing costs or benefits.
The retail CFD business is a Pareto business: a small minority of customers generates the
majority of revenues:
1. Experienced, consistently profitable customers accelerate their ​profits ​and our
business with leverage and grow to represent
a. the ​minority​ of customers that
b. generates the ​majority​ of revenues
2. Inexperienced customers - possibly incentivised into leverage by their providers’
conflict of interest represent a vulnerable majority (in numbers but not revenue) that
must be protected
In summary: ​retail does not (in every case) amount to inexperienced​. The standard
MiFID professional definition fails to account for this.
We expect a one-off cost volume reduction effect from the leverage restriction, which will
most affect our largest and most profitable ​retail​ customers. The permanent long term cost to
both our business and our clientele will be to drive away experienced users from the CFD
market. To the extent that said users provide peer counseling and information to more
inexperienced users - this will be also result in bad outcomes for vulnerable customers.
C: What impact do you consider that the introduction of a margin close-out rule on a
per position basis (applying to retail clients only) would have on your business?
Please describe and explain any one-off or ongoing costs or benefits.
If applied in conjunction to ​the proposed leverage​ restriction, the margin-close out rule will be
largely unnecessary / ineffective. Its contribution to customer protection will be marginal at
best, to the extent that leverage restrictions render close-outs unlikely.
Implementing the margin close-out on a per position basis will require significant investment
into software changes, and will hamper both the effectiveness and the reliability of existing
systems and operational procedures in the transitional period.

4. In other words, the margin close out rule as proposed is a heavy-handed intervention with
limited, if any, positive side-effects.
D: What impact do you consider that the introduction of negative balance protection
on a per account basis (applying to retail clients only) would have on your business?
Please describe and explain any one-off or ongoing costs or benefits.
Negative balance protection is a free implied option (free insurance!) to be gifted by
providers onto customers, and as such is a case study in ​moral hazard
1. That encourages customers to take on ​more​ not ​less​ leverage​ - ​e.g. it undermines
the effectiveness of the leverage restrictions in protecting vulnerable customers
2. Perversely incentivised customers stand to benefit by placing bets on both sides of a
trade with different providers, thus benefiting from volatility spikes as they increase
counterparty risk in the system
3. The cost of gifting free insurance to risk takers will be cross-subsidized
a. Directly by low risk customers: via increased spreads and/or commissions to
finance the value of said free option
b. Indirectly: via the increased solvency risk implied by ​increased​ not ​reduced
leverage on provider balance-sheets
Furthermore, negative balance protection distorts competitive supplier dynamics ​against
providers clearing ​CFDs on venues ​in that:
1. Negative balance is an economic impossibility when CFDs are internalised
2. Negative balance protection passes on counterparty risk from leveraged induced
(free insured) final customers, up the provider chain to increase broader system risk
3. Intermediating CFDs and offering negative balance protection are economically
incompatible - this will crowd out brokerage providers from the market
In other words, negative balance protection is a case study of regulation introducing moral
hazard. It affects our business in that it imposes on us a market risk that we have chosen
NOT to carry to align our incentives with the retail customers we’ve chosen to serve. Being a
broker​ (pure intermediary) is incompatible with offering negative balance protection.
E: What impact do you consider that a restriction on incentivisation of trading
(applying to retail clients only) would have on your business? Please describe and
explain any one-off or ongoing costs or benefits.
This specific measure is a clear example of tackling the symptom at the expense of the root
illness. Systematic CFD internalisers
1. Can afford to spend upwards of USD 1.000-1.500 advertising to a new vulnerable
customer because
2. It’s profitable to fully Internalise said customers losses 1:1

5. If said provider had to compete with other market participants by making liquidity in a
competitive order-book the systematic profit of internalisers would go, and with it the
advertising budget (and indeed the incentive to advertise leverage).
This measure will be largely ineffective for every smart CFD internaliser will:
1. Advertise the trading of stocks and/or futures to attract customers into trading,
2. Knowing fully well that customers will choose to trade CFDs because of the superior
nature of CFDs vs cash settled markets when it comes to trading
F: What impact do you consider that a standardised risk warning (applying to retail
clients only) would have on your business? Please describe and explain any one-off
or ongoing costs or benefits.
We have provided standardised risk warnings to customers for years.
We don’t expect standardised warnings to have any impact on our business, nor do we think
they will serve any purpose unless regulators tackle the underlying conflict of interest at root.
Standardised risk warnings will have minor impact as long as providers are allowed to
internalise retail customer losses.
G: Please provide evidence on the proportion of retail clients that use these products
for hedging purposes and how the suggested measures will affect them.
It is very difficult for us to provide said evidence since by its very nature, we only see a trade
that may or may not be hedging an economic risk ​unhedgeable​ other than by taking the
opposite side of the trade.
H: What impact do you consider that a prohibition on providing binary options to
retail clients would have on your business? Please describe and explain any one-off
or ongoing costs or benefits.
We have always believed binary options to be an inadequate product for customers, and
have therefore chosen not to offer them.
We believe however that most providers of binary options have left the market to focus on
offering CFDs on cryptocurrencies. We sincerely believe that whatever benefits vulnerable
customers derive from the prohibitions of binary options are already offset by internalised
CFDs on crypto-currencies.
I: What impact do you consider that the envisaged measures would have on retail
investors?
Because the ​average​ CFD customer is vulnerable, the initial one-off effect of the envisaged
measures will be positive ​on average.​ However, this regulation will not contribute to

6. self-regulation in that existing dynamics ​favouring ​better outcomes are hampered by the
one-size fits all nature of the regulation.
We believe far more long term impact, and far less short term negative impact would be
achieved if you regulated CFDs as follows:
3. Your proposed prohibitions on binary options
4. No restrictions on CFDs traded either:
a. By professionals, ​OR
b. CFDs cleared on Mifid regulated MTFs, including Crypto-Currencies
5. Your proposed restrictions on any internalised CFDs - including CFDs on
crypto-currencies
J. Do you believe that specific restrictions concerning CFDs in cryptocurrencies
should be introduced? In particular, what impact do you consider that assigning a
leverage limit of 5:1 to such CFDs would have on firms’ business and / or any
expected additional benefits for retail clients? How would such an impact compare to
that from the possible alternatives of lower leverage limits such as 2:1 or 1:1, or a
prohibition on the sale, marketing and distribution of such CFDs? Please describe
and explain any one-off or ongoing costs or benefits.
CFDs on cryptocurrencies are economic equivalent to CFDs on any underlyings, and we
wholeheartedly believe that they should be regulated as such. If leverage limits are imposed
on other instruments on the basis of the volatility of their underlying, the same principles
ought to apply to crypto-CFDs.
Furthermore, we believe the market would self-regulate towards better consumer outcomes
if crypto CFDs trading on venue were to be exempted from any restrictions.
Best regards