Leverage limits and negative balance protection: the rules retail traders rely on

Before 2018, a retail client could open a forex account with a European broker and trade at 200:1 or more. That era ended when the European Securities and Markets Authority used new product intervention powers to restrict how contracts for difference are sold to retail investors. The UK and Australia followed with their own versions. Together they form the baseline that most well-regulated brokers now work to.

The ESMA measures of 2018

ESMA announced its package on 27 March 2018, and the CFD restrictions applied from 1 August 2018. They had five parts.

Leverage caps on opening positions, graded by the volatility of the underlying:

• 30:1 for major currency pairs, meaning any pair made up of two of the US dollar, euro, yen, sterling, Canadian dollar and Swiss franc
• 20:1 for other currency pairs, gold and major equity indices
• 10:1 for commodities other than gold and for non-major equity indices
• 5:1 for individual shares and other reference values
• 2:1 for cryptocurrencies

A margin close-out rule. When the funds in a retail client’s CFD account fall to 50% of the margin needed to keep positions open, the provider must close one or more of them. This is applied per account.

Negative balance protection, also per account. A retail client’s losses on CFDs cannot exceed the funds in their CFD account.

A ban on incentives. Providers may not offer bonuses, gifts or similar inducements to encourage trading.

A standardised risk warning that includes the percentage of the provider’s own retail accounts that lost money. That figure is one of the most useful numbers a prospective client can look at.

ESMA’s powers were temporary, so it renewed the measures in three-month instalments. Between 2019 and 2020 national regulators across the EU adopted permanent measures of their own, largely on the same terms, and these now do the work ESMA’s temporary rules once did.

The UK and Australia

The Financial Conduct Authority made its version permanent with policy statement PS19/18. The rules applied to CFDs from 1 August 2019 and to CFD-like options from 1 September 2019, with the same range of leverage limits from 30:1 to 2:1, the 50% close-out, negative balance protection and a ban on inducements. The FCA went further on crypto: since 6 January 2021 it has banned the sale of cryptoasset derivatives to retail clients altogether.

Australia’s regulator took a similar path later. ASIC’s product intervention order took effect on 29 March 2021. It sets the same leverage caps (30:1 for major currency pairs, 20:1 for minor pairs, gold and major indices, 10:1 for other commodities and minor indices, 5:1 for shares and 2:1 for crypto-assets). It requires positions to be closed out when a client’s account falls below 50% of the total initial margin required, limits losses to the funds in the CFD account and bans certain inducements such as trading credits and free gifts.

In its first six months, ASIC reported, aggregate net losses on retail client accounts fell by 91% on a quarterly average basis. The order was extended in 2022 and now runs until 23 May 2027 unless it is remade.

The rules protect a category of client, not a brand. Change the entity or the classification and the protection can disappear.

Professional clients are outside the rules

The protections apply to retail clients. Under EU and UK rules, a retail client can ask to be treated as an elective professional if a firm assesses them as having enough expertise and they meet at least two of three tests: trading in significant size at an average of ten transactions a quarter over the previous four quarters, a portfolio of cash and financial instruments above €500,000, or at least a year working in the financial sector in a relevant role.

Opting up can unlock higher leverage. It also removes the leverage caps and, depending on the firm, may remove negative balance protection and other retail safeguards. The FCA has criticised firms for accepting weak answers when categorising clients as professional, so a broker that pushes you towards the upgrade deserves scrutiny.

Offshore entities are outside them too

The caps bind the regulated entity and its retail clients. Many brands also run companies in other jurisdictions where leverage of several hundred to one is still offered. A client who registers with that entity, sometimes after being redirected from the regulated one, generally loses the EU, UK or Australian protections, along with access to the compensation scheme and ombudsman attached to them.

ESMA has warned about firms outside the EU that rely on tick-box statements claiming the client approached them on their own initiative, a practice known as reverse solicitation. Before opening an account, check which legal entity you are contracting with and which regulator supervises it.

What to check

• The leverage offered on each asset class, against the caps above.
• The percentage-of-losing-accounts figure in the risk warning.
• Whether the account has negative balance protection, in writing.
• Which entity holds your account, and whether you are classed as retail.

Leverage limits do not make CFDs low risk. They set a ceiling on how fast losses can build, and knowing where that ceiling sits is part of choosing a broker.