ESMA CFD Rules: CFD Trading Regulation in Europe

In 2018, the European regulator ESMA (European Securities and Markets Authority) introduced major changes for CFD traders in the European Union. These ESMA CFD rules were designed to protect retail clients, as ESMA considered that CFD trading is not suitable for all private clients — a view driven by excessive use of leverage and money lost in the past. In this article, we look at the main differences between the two statuses, ESMA professional or retail trader, so you can make a fully informed choice of the status that best suits your trading.

ESMA regulation: retail clients and professional clients

In August 2018, CFD brokers introduced different CFD trading offers for different types of clients. ESMA applied the MiFID II rules to distinguish between professional and retail clients. Clients of brokers regulated in the European Union (ECN brokers) are therefore classified into two groups: the “default” group is retail clients.

Because CFDs are leveraged financial instruments (with maximum leverage of 1:500 for professional clients), potential gains are multiplied — but so are potential losses. ESMA therefore considers that highly leveraged trading is not suitable for all investors and, from August 1, 2018, introduced measures to protect retail clients from potential losses.

On related topics, our articles “The best French CFD trading platforms” and “Gold ETFs” are a good complement to this read.

Retail clients

Under the new ESMA regulation, retail clients gained unlimited protection against additional funding obligations (margin calls beyond their deposit) in their CFD trading. Retail clients must also limit their maximum leverage because of the risk of capital loss and of losing too much money through excessive leverage.

At the same time, retail clients benefit from enhanced protection in their trading, including:

Unlimited negative balance protection: if your account balance falls below zero due to unforeseen market moves, we will automatically reset your balance to zero. This ensures you cannot lose more than your initial deposit.
Enhanced regulatory protection: benefit from all the regulatory protections granted to retail clients, including the option of using the Financial Ombudsman Service (dispute resolution service).

Professional clients

Professional clients, for their part, are considered highly experienced and can therefore use leverage of up to 1:500 in their CFD trading. However, to become a professional client, you must submit a categorization request.

An investor can ask to be classified as a professional client. To be eligible, certain qualitative, quantitative and regulatory requirements must be met. Professional client status comes with certain features, including:

Lower margin requirements (higher leverage): you trade with margin rates 15 to 25 times lower than retail clients, with leverage of up to 1:500.
Bonus programs: get full access to all current and future bonus programs and special offers.
Priority access to new products: get the chance to trade and invest in new products before they are rolled out to the full client base.

ESMA leverage: maximum leverage levels for retail clients

For an experienced trader, leverage is a double-edged sword, since it multiplies profits but also increases the risk of loss. Beginner traders often lack this kind of information, which is why ESMA decided to create the retail client classification.

As a result, ESMA decided that retail clients would have maximum leverage of 20 on the most traded stock indices (DAX 40, etc.). This came into force on August 1, 2018 in the European Union and is applied by all CFD trading brokers.

For forex traders, however, the maximum leverage applicable to major currency pairs is set at 30.

ESMA CFD: conditions for professional clients

CFD brokers can continue to offer high leverage to experienced professional clients. Professional clients are considered extremely experienced in CFD trading, so CFD brokers are not required to offer protection against additional funding. Depending on the provider, this may mean these clients face margin risk.

This policy protects regular CFD trading activity against margin requirements up to £50,000 per client. Clients comparing brokers’ offers for professional clients should definitely take a protection measure into account.

ESMA CFD leverage: how leverage works in trading

Built-in leverage is one of the reasons traders choose CFDs. In traditional unleveraged stock trading, typical potential returns of three to ten percent are realistic (for the whole year) — outliers aside. With leveraged products such as CFDs, returns of ten to fifty percent in a single day are possible and common, depending on the leverage — but so are losses.

Since the size of the leverage also multiplies losses, from August 2018 inexperienced retail clients are also “protected from themselves”. Leverage above 30 on major currency pairs is no longer available to this group of clients.

In CFD trading, leverage reflects the margin required to open trading positions. Trading CFDs on margin allows both buy and sell orders, so you can trade both rising and falling prices.

Margin is simply the amount you need as a deposit in your trading account to open a position. The rest is borrowed from your broker.

Example: with leverage of 1:500, you make a 500% gain or loss on a 1% market move!

Leverage therefore lets you trade the financial markets even with small trading capital — in both directions.

This is why strict risk management (with the help of a well-placed stop loss) and trading experience are essential. Leverage is highly speculative.

Forex leverage for retail and professional clients

Under the new standards introduced by ESMA for CFD trading, the question “How do I choose my leverage?” becomes essential. Below are the maximum leverage levels by account status and type of trading instrument.

Leverage limits for retail client accounts:

1:30 (3.33% margin) for major forex pairs;
1:20 (5% margin) for major index CFDs, minor and exotic forex pairs, and gold CFDs;
1:10 (10% margin) for commodities other than gold;
1:5 (20% margin) for individual stocks (stock CFDs) and other underlyings

Leverage limits for professional clients

Up to 1:500 (0.2% margin) for major and minor forex pairs, as well as for the main indices (ASX200, DAX30, DJI30, FTSE100, NQ100, SP500) and certain commodities (gold, silver, XAUAUD, WTI and Brent);
Up to 1:200 (0.5% margin) for other indices and bonds;
Up to 1:100 (1% margin) for other commodities;
Up to 1:25 (4% margin) for exotic forex pairs;
Up to 1:20 (5% margin) for individual stocks (stock CFDs).

Note that the maximum leverage available to professional clients is based on the notional value of the position in the trading account’s currency. The largest positions in terms of size will therefore not necessarily have access to maximum leverage.

Additional payment liability under ESMA forex rules

The start of 2017 marked the introduction of protection for German clients against additional payment obligations. This is ensured by BaFin (the German Federal Financial Supervisory Authority).

ESMA is responsible for standardizing protection against additional funding obligations across the European Union. In addition, retail clients benefit from unlimited protection under ESMA’s forex requirements. As a result, extreme events known as “black swan events” no longer hold the same fear for the industry.

However, there is no regulatory protection for professional clients. This leaves them exposed in the event of extreme market events, and they will then be required to pay the amount owed. That’s why it’s essential to choose a platform that can protect you with negative balance protection.

Retail trader or professional trader: which status is best?

While traders’ first concern is usually choosing their client status and the leverage to use, it is first and foremost necessary to look at your trading experience.

A beginner in forex and CFD trading should opt for a standard account with retail client status. This means trading with lower leverage and greater protection. Note that leverage is a double-edged sword: on the one hand, it can multiply potential gains, but it can also multiply potential losses. The limit placed on retail clients protects them from the scale of potential losses.

By contrast, forex and CFD accounts for professional clients can benefit from higher leverage — which, of course, comes with fewer regulatory restrictions.

So how do you become a professional forex trader? To check whether you are eligible to open a professional trading account, ask yourself these 3 questions:

Have you carried out 10 trades of significant size per quarter over the previous four quarters in the relevant markets?
Does your portfolio of financial instruments exceed €500,000?
Have you worked for at least one year in the financial industry, as an employee or self-employed?

If you can answer yes to these questions, you can apply for professional status under ESMA rules. It will then be checked whether your experience and knowledge are sufficient to make investment decisions — and above all whether you have an adequate understanding of the risks involved in trading positions.

ESMA CFD: how to become a trader with professional client status

To obtain professional trader status and request a change of account status, you fill in a form. The request to switch to professional status must be made with your platform.

If you want to move toward professional trader status but your knowledge is still limited, you can build up your experience with the training offered by the broker DEGIRO. Once you’re ready, you can then change your status.

What if you are not eligible for professional client status?

If you are not eligible for professional client status, you can keep your retail client status.

This still lets you trade 7,500 trading instruments across different markets — and, above all, take long or short positions on the markets, with leverage of up to 1:30. You can also access the best-known and most popular platforms, MetaTrader 4 and MetaTrader 5.

This of course depends on your choice of broker. We recommend DEGIRO for this.

Conclusion: has ESMA regulation changed CFD trading?

Regulation to protect inexperienced investors is more than necessary. August 2018 saw ESMA introduce protection for EU CFD traders against major risks — protection that even extends to limiting leverage. However, this leverage limit does not apply to accounts with professional client status.

CFD trading nonetheless remains open to investors whatever their trading style. They can still profit from both rising and falling prices with CFDs.