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Analysis: Germany’s Ultimatum to CFDs Brokers – Negative Balance No More

Negative balance protection is becoming a must even for STP brokers. Contracts with an additional payments obligation, such as margin, will soon not be available to retail clients in Germany.

It has been almost 2 years since the Swiss National Bank suddenly announced that it would no longer hold the Swiss franc at a fixed exchange rate with the euro. This jolted currency markets worldwide and many forex traders found themselves on the wrong end of the stick. With the ‘anniversary’ date approaching, the regulatory consequences from the event are starting to reverberate.

Germany’s Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) announced new rules Thursday designed to protect retail investors, becoming the latest European regulator to move to limit the expansion on the fast-growing industry in which many retail investors end up losing money.

Shares in CMC Markets, IG Group, Plus500 and other listed brokers traded down after Germany’s Federal Financial Supervisory Authority (BaFin) announced it planned to restrict the marketing, distribution and sale of CFDs to private investors. The industry watchdog Bafin stated that the sale of CFDs will not be permitted unless providers offered ‘limited risk accounts’ where clients’ maximum exposure is limited to their account balance.

“In the case of CFDs with an additional payments obligation, the risk of loss for the investor is incalculable,” Bafin Chief Executive Director Elisabeth Roegele said. “For consumer protection reasons, we cannot accept that,” she added.

Germany’s measure is arguably one of the most effective as far as consumer protection is concerned. The terms can’t be clearer – providers that want to provide their services to German residents can do so, as long as they protect clients from negative balances.

The regulator considers that leveraged trading is akin to trading with borrowed money. Financial CFDs with no downside protection may lead to price gaps and in some cases require the trader to end up paying much more than the amount they initially invested. BaFin doesn’t consider stop loss orders and margin calls as effective protection in limiting client losses in such instances. In fact, they could lead to incremental losses since investors’ positions could be forcibly closed at highly unfavorable prices.

The regulator lists several main risks associated with CFD trading – the complexity of performance calculation, speculation on credit, lack of transparency when it comes to calculation of underlyings where there are price gaps, no limitation on the risk of loss through the margin call procedure, and no limitation of the risk of loss by stop-loss orders, among others.

The regulator noted that CFDs do have some advantages compared to direct investments but CFD providers mainly targeted retail clients. Currently the CFD trading industry enjoys relative freedom in the European Union with no caps on leverage. That means retail investors can take out bets that are far bigger than their initial deposit, offering much larger potential returns but also running the risk of amplified losses. In the past German clients were held personally liable for losses if these happened to exceed the balance of their CFD brokerage accounts.

BaFin published on Thursday a draft General Administrative Act concerning the issue. Once the rules are approved, they will come into effect within three months of that date. Thursday’s move came after three UK-listed spread betting companies saw their share prices plunge by more than a third on Tuesday after Britain’s Financial Conduct Authority said it planned to bring in new rules for the sector.

Some providers already offer limited risk accounts that are meant to prevent client from incurring losses in excess of the amount deposited in their account, however in future this will be a requirement.

The main participants in the German CFD market will be meeting Bafin representatives, who have allowed until January 20, 2017 for consultations on the new ban. The ruling may result in some changes for high net individuals who may have to be reclassified as professional investors in order to continue receiving STP access to the market without the negative balance protection.

Last week, the financial regulator in Cyprus, where a number of CFD providers are registered, also sounded a warning to companies about the bonuses they offer to customers.

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