More about this proposal
ESMA is considering a number of proposals aimed at retail traders, to try to increase conduct standards across the industry. While many of the proposals are sensible, this site focuses on the two that are likely to have a significantly negative effect on traders.
ESMA is suggesting a 50% margin close-out rule on a position-by-position basis, rather than on an account basis.
To put this into context, a CFD with a 5:1 leverage limit would have an initial margin rate of 20% of the initial total exposure. Under ESMA's proposal, if the margin allocated to that position then fell below 10% of the initial total exposure, the CFD would be closed out - regardless of how much money was available on the account.
Traders could, however, choose to allocate additional (variation) margin to a particular position, both at the point of opening the position and during the lifetime of that position.
How could this proposal affect traders?
- Say you have £2,000 in your account and you open a DAX position that requires £1,000 margin. When that position runs a loss of £500 (so £500 is the remaining margin allocated to the position after the running loss), your broker will be forced to close your position irrespective of the cash on your account, and irrespective of profits on other positions.
- Using the example above, imagine you decide to allocate the whole £2000 to the same DAX position. ESMA proposals will force your broker to close the position when the running loss is £1,500 (£2,000 minus £500). This is because the position must still be closed out when the remaining margin allocated to that position - after the running loss - is equal to 50% of the initial margin requirement.
In summary: the initial margin is £1,000, and 50% of this is £500. You allocate £2,000 to the position. When only £500 of the £2,000 is left, the position must be closed out.
While considering your risk on each position is important, these rules are complex and unclear. And the risk is that traders will have to keep switching their allocation of margin from one position to another in order to minimise the chance of each position being closed out, even when their overall account is in profit.
You can read the proposals in full here, and
see what industry leaders have to say about them.