Battling with the uncertainties of CFDs and Cryptocurrency in 2018
28 March 2018
In the new age of virtual currency trading, reports indicate that the global value of the cryptocurrency market surpasses $600 billion. Although the markets have seen a spiral momentum, the large businesses continue to thrive, leaving the midsize/small investment brokerage firms under struggle with the harsh impositions that are continually enacted by Cyprus Securities and Exchange Commission (“Cysec”) and The European Securities and Markets Authority (ESMA).
The below information evaluates and explores the current restrictions that Cyprus Investment Firms (“CIFs”) are currently facing regarding Contracts for Differences (“CFDs”) and CFDs relating to Virtual Currencies.
CFDs relating to Virtual Currencies (Cryptocurrency)
Circular C244 issued by Cysec dated 13th October 2017 gave specific guidelines for all CIFs desiring to proceed with offering Cryptocurrency. Cysec gave particular emphasis to the fact that CFDs relating to Virtual Currencies are not governed by any specific EU regulatory framework.
Due to the lack of regulation surrounding these types of products, certain impositions were released by Cysec in order to ensure the safeguarding of clients and investors of CIFs, namely the following:
- CIFs must warn all clients/investors before providing any services to clients in virtual currencies and/or CFDs relating to virtual currencies in relation to these products the following information:
- there is no specific EU regulatory framework governing the trading of Cryptocurrency.
- Trading in such products is not covered by MiFID and therefore falls outside the scope of the CIFs’ MiFID regulated activities.
- A number of risks are associated with these products and these should be stipulated in a specific risk warning.
- Such products are complex and high risk and therefore invlove a high risk of losing all the invested capital.
- Virtual currencies values can widely fluctuate (high volatility) and may result in significant loss over a short period of time.
- Virtual currencies are not appropriate for all investors and therefore, investors should not trade in such products if they don’t have the necessary knowledge and expertise in this specific product. Invstors must be made fully aware and be given specific warnings that they understand the specific characteristics and risks related to these products.
- Trading in such products does not entitle the investors to any protection under the Investors Compensation Fund.
- They have no rights to report to the Cyprus Financial Ombudsman in case of a dispute with the CIF.
- All risks must be properly recorded.
- Virtual currency exchangers and liquidity providers that provide the feeds to the CIFs must be fully regulated and must undergo due diligence by the CIF prior to signing any contracts. Checks of the said feed providers must be done periodically.
- CIFs must clearly disclose to the public the methodology used to calculate the bid and ask prices of such products.
- CIFs should use more than one feed provider and should cross-check with other feed providers in order to ensure that best execution principles are followed. Where only a single feed provider is used, CIFs must be able to determine and record how their best execution obligations are held.
- For all retail clients the leverage limit should be set 5:1 for trading on CFDs relating to virtual currencies.
- Passporting of these products in the European is not permitted without the approval from the relevant applicable country prior to offering CFDs on virtual currencies to any country.
- The CIFs turnover of income derived form CFDs on virtual currencies should not exceed 15% of the total turnover of the CIF per quarter.
On the 27th March 2018, ESMA issued a press release regarding the proposed restriction of CFDs (ESMA71-98-128 ), specifically affirming that a restriction on the marketing, distribution or sale of CFDs to retail investors shall be imposed. This restriction consists of: leverage limits on opening positions; a margin close out rule on a per account basis; a negative balance protection on a per account basis; preventing the use of incentives by a CFD provider; and a firm specific risk warning delivered in a standardised way.
The product intervention measures ESMA has agreed under Article 40 of the Markets in Financial Instruments Regulation include:
- Leverage limits on the opening of a position by a retail client from 30:1 to 2:1, which vary according to the volatility of the underlying:
30:1 for major currency pairs.
20:1 for non-major currency pairs, gold and major indices.
10:1 for commodities other than gold and non-major equity indices.
5:1 for individual equities and other reference values.
2:1 for cryptocurrencies.
- A margin close out rule on a per account basis. This will standardise the percentage of margin (at 50% of minimum required margin) at which providers are required to close out one or more retail client’s open CFDs;
- Negative balance protection on a per account basis. This will provide an overall guaranteed limit on retail client losses;
- A restriction on the incentives offered to trade CFDs; and
- A standardised risk warning, including the percentage of losses on a CFD provider’s retail investor accounts.
Due to the ever-changing regulatory status of CFDs and CFDS on virtual currencies, CIFs are now undergoing vast changes to their business models in order to facilitate the uncertainty of 2018. The large transitions that CIFs will undergo due to the fluctuating regulatory pressure, and specifically, in accordance with The Markets in Financial Instruments Directive II (“MIFID II”), has caused for the exploration of new strategies and the consideration of diversification outside of Europe to help sustain their businesses.
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Head of Financial Services and Capital Markets
The above is for information purposes only and does not constitute advice.