As of August 2018, EU brokers are no longer permitted to offer high-risk leverage on CFDs to their clients; leverage for CFDs on major currency pairs is capped at 30:1, while leverage for cryptocurrency CFDs is capped at 2:1.
However, these ESMA CFD restrictions apply only to “retail traders” and not to “professional traders.” The latter can still trade CFDs with high leverage. This leaves a buffer for brokers, as many of their existing clients are currently classified as professional traders, and brokers can continue to offer them the same trading conditions.
Which traders can be classified as professional traders?
This is one of the key issues that ESMA and EU brokers have been working to resolve. In November 2018, ESMA required European brokers to provide data on the number of retail and professional clients trading CFDs with them.After extensive deliberation, regulators identified several key criteria; traders who meet these criteria can be classified as professional traders (EPCs). So, which traders can be classified as EPCs? ESMA’s classification criteria cover three dimensions: trading experience, trading knowledge, and portfolio size.
According to the standards set by ESMA, a professional trader must meet at least two of the following three criteria:
- At least 10 large transactions in each of the past four quarters
- One year of experience in the financial industry
- A portfolio worth at least 500,000 euros
Become a Professional Foreign Exchange Trader
Traders wishing to be classified as EPCs must submit a written application and provide supporting documentation.They must then sign a waiver acknowledging that they will bear the consequences of losing the protections associated with “retail trader” status. Additionally, they will undergo an assessment to ensure their trading skills and market understanding meet the requirements for “professional trader” status.
At most brokerage firms, EPCs—with their high-net-worth portfolios—account for the majority of the firm’s revenue. One well-known brokerage firm reported that 12% of its clients contributed more than 75% of its profits.
According to other industry veterans, the general rule for brokerage firms is the “10/90 rule,” meaning that 90% of profits are generated by 10% of clients. This implies that even in an era of heightened regulation, the accurate classification of high-quality clients allows most brokerage firms to maintain the same profit levels.
Higher Industry Standards
Given the immense market potential of professional traders, the primary objective of the ESMA guidelines is to prevent unscrupulous brokers from exploiting regulatory loopholes.The ESMA guidelines clearly define brokers’ obligations and responsibilities within the financial industry, leaving virtually no legal loopholes for unscrupulous brokers to exploit. ESMA’s new regulations have once again raised the bar for the retail forex trading industry, making the forex trading environment safer and more regulated.
The CEO of Leverate, a leading provider of brokerage technology and services, expressed support for these new measures: “Properly classifying your traders and distinguishing between novice and professional traders helps the forex industry become more standardized, while bringing greater confidence to both clients and businesses.We are convinced that the future of the forex industry depends on adherence to high standards of practice, and that a transparent, regulated brokerage firm is the foundation of success.”
Currently, brokers regulated by the EU need to revamp their websites and client segmentation to adapt to the new client classifications. RegTech and compliance service providers are also working tirelessly to adjust their solutions so that their clients can comply with the new guidelines.
