ESMA CFD – Regulation for CFD trading in Europe

In 2018, the European regulator ESMA (European Securities and Markets Authority) implemented significant changes for traders of CFDs in the European Union. This regulation has enabled retail clients to be protected as ESMA has deemed that CFD trading is not suitable for all retail clients. Besides, this is due to the excessive use of leverage and loss of money in the past. We will see through this article the main differences between these two statuses, esma trader pro or individual, in order to allow you to choose in full knowledge of the facts the most appropriate status in relation to your trading.

ESMA Regulation – Individual Clients and Professional Clients

In August 2018, different offers regarding CFD trading were put forward by CFD brokers for different clients. Moreover, ESMA has imposed the MiFID II regulations to distinguish between professional and private clients. Clients of brokers regulated in the European Union (ECN brokers) are therefore classified into two groups: the "default" group is the group of Retail Clients.

CFDs being leveraged financial instruments (with a maximum leverage effect of 1:500 for Professional clients), this means that the potential gains are multiplied, but the potential losses are just as much. Therefore, ESMA considers that highly leveraged transactions are not suitable for all investors and has put in place, as of August 1, 2018, measures to protect Retail clients from potential losses.

Individual Clients

Under the new ESMA regulation, Individuals clients have benefited from unlimited protection against additional funding obligations in their CFD trading. Moreover, retail clients must limit their maximum leverage because of the risk of losing capital and losing too much money due to too much leverage.

Meanwhile, 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 changes, we will automatically reset your balance to zero. This guarantees that you will not lose more than your initial deposit.
• Enhanced regulatory protection: Take advantage of all the regulatory protections afforded to Retail clients, including the ability to use the Financial Ombudsman Service (Dispute Management Service).

Professional Customers

As for professional clients, they are considered very experienced so can enjoy leverage in their CFD trading to a maximum of 1:500. However, in order to become a professional client, a categorization request must be appropriated.

It is possible for an investor to ask to be classified as a Professional client. To be eligible, certain qualitative, quantitative and regulatory requirements must be met. The status of Professional client has certain characteristics, in particular:

• Reduced Margin Requirements (Higher Leverage): You trade with margin rates 15-25x lower than Retail clients, with leverage 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 ability to trade and invest in new products before they are released to the full customer 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. Moreover, this kind of information is lacking in novice traders, which is why ESMA decided to create the classification of retail clients.

As a result, ESMA has decided that retail clients will benefit from a maximum leverage effect of 20 for the most traded stock market indices (DAX 40,…). This was implemented on August 1, 2018 in the European Union and is applied by all CFD trading brokers.

However, for Forex traders, the maximum applicable leverage for major currency pairs is set at 30.

ESMA CFD – Conditions for Professional Clients

CFD brokers have the option of continuing to offer high leverage for experienced professional clients. Professional clients are considered extremely experienced in CFD trading, so CFD brokers are not required to offer additional funding protection. Depending on the provider, this may mean that there are margin risks for these customers.

This policy protects regular CFD trading activities against required margins up to £50 per client. Customers who check the brokers' various offers for professional clients should definitely take a protective measure into consideration.

ESMA CFD Leverage – Leverage in Trading

The built-in leverage is one of the reasons traders choose CFDs. In traditional non-leveraged stock trading, the usual potential returns of three to ten percent are realistic (for the whole year) – except for outliers. For leveraged products such as CFDs, returns of ten to fifty percent in a single day are possible and common, depending on leverage but also possible losses.

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

In CFD trading, leverage reflects the margin required to enter trading positions. Margin CFD trading allows buy and sell orders, thus highlighting up and down prices.

Margin is the amount you only need as a margin deposit in your trading account to trade a position. The rest is a loan from your broker.

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

Leverage therefore makes it possible to operate on the financial markets, even with low trading capital – in both directions.

Thus, strict risk management (with the help of a cleverly defined stop loss) and experience in trading are necessary. Leverage is highly speculative.

Forex Leverage in – Individual Clients and Professional Clients

According to the new standards introduced by ESMA in terms of CFD trading, the question: "How to choose your leverage effect?" becomes necessary. We will show you below the maximum leverage effects depending on the status of the account and the type of trading instruments in question.

The leverage limit of Retail client accounts:

• 1:30 (3.33% margin) for major Forex pairs;
• 1:20 (5% margin) for major indices CFDs, minor and exotic Forex pairs and also Gold CFDs;
• 1:10 (10% margin) for other commodities except gold;
• 1:5 (20% margin) for individual stocks (stock CFDs) and other underlyings

Leverage Limit – Professional Clients

• Up to 1:500 (0,2% margin) on Major and Minor Forex pairs. But also for the main indices (ASX200, DAX30, DJI30, FTSE100, NQ100, SP500), and also for 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 raw materials;
• Up to 1:25 (4% ​​margin) for Exotic Forex pairs;
• Up to 1:20 (5% margin) for individual stocks (stock CFDs).

It should be noted that the maximum leverage open to professional clients will be based on the notional value of the currency position within the trading account. Indeed, the most important positions from the point of view of size will not necessarily be able to have access to the maximum leverage effect.

The Additional Payment Liability in ESMA Forex

The beginning of 2017 marks the implementation of the protection of German customers against additional obligations. This is ensured by BaFin (German Federal Financial Supervisory Authority).

The standardization of protection against additional funding obligations is the responsibility of ESMA within the European Union. In addition, retail clients will benefit from unlimited protection due to Forex ESMA requirements. This has the effect of making extreme events known as “Black Swan Events” fearless in the industry.

However, regulatory protection for professional clients is non-existent. This will have the effect of leaving them prey to contingency in the event of extreme events on the market. So they will then be required to pay the said amount. This is why it is necessary to choose a platform that can protect you against the Negative Balance.

Private Trader or Professional Trader – Which is Better?

If basic, the first concern of traders is in the choice of client status, as well as the leverage effect to be used. First of all, it is necessary to look first and foremost at trading experience.

A beginner in Forex and CFD trading is called upon to opt for a standard account in the status of a particular client. This includes trading with lower leverage and greater protection. It is noted that leverage is a double edged sword. On the one hand, it can multiply potential gains, however it can also multiply potential losses. The limitation placed on retail clients protects them against the magnitude of potential losses.

On the other hand, accounts suitable for professional Forex and CFD clients will be able to benefit from a greater leverage effect. But this is obviously accompanied by a relaxation of regulatory restrictions.

So how do you become a Professional Forex Trader? In order to check your eligibility for opening a Professional trading account, ask yourself these 3 questions:

• Did you enter 10 positions of significant size per quarter during the previous four quarters in relevant markets?
• Does your portfolio of financial instruments have a balance exceeding €500?
• Have you worked for at least one year in the financial industry, as an employee or self-employed?

If you get an affirmative answer to these questions, you can request professional status from ESMA. He will then check whether your experience and knowledge are sufficient to make investment decisions. But above all to know if you have the adequate understanding for the risks in trading positions.

ESMA CFD – How to Become a Trader with Professional Client Status?

In order to access the status of professional trader and request a change in the status of the account, the process is done via a form. A request for the change to professional status must be made to your platform.

If your interest is to evolve towards the status of professional Trader but your achievements are minimal. It is possible to strengthen your experience with the training offered by the broker DEGIRO. Once ready, you can then change the status.

In the event of Ineligibility for Professional Client Status?

If you are deemed ineligible for the status of Professional client, it is possible for you to maintain the status of individual client.

This offers you the possibility of trading 7500 trading instruments present on different markets. But above all, the possibility of taking a position on the rise or the fall on the markets. This comes with a leverage of up to 1:30. In addition, you will also be able to access the best and most popular platforms such as MetaTrader 4 and MetaTrader 5.

This is of course conditioned by your choice of broker. We recommend that you turn to DEGIRO for it.

Conclusion: Has ESMA Regulation caused CFD to evolve?

Regulation to put in place protection for inexperienced investors is badly needed. The month of August 2018 saw the implementation of the protection of EU CFD traders by ESMA against major risks. This protection even goes to the limitation of the leverage effect. However, this limitation of the leverage effect is not admissible for the account benefiting from the status of professional client.

Trading CFDs is however always open to the investor regardless of the type of trading. It is indeed still possible for the latter to reap profits via the rise and fall of prices with CFDS.