As with any new products or products which are not well classified and understood by regulators and market players alike, there is always the issue of regulation of the brokers and the entire market itself. When the CDO derivative products created around the US subprime housing market were introduced, many investing entities which included foreign municipal governments put their money in them without really understanding what they were all about. As long as the housing market was doing well, the general consensus was that it was ok to invest in the credit default swaps and CDOs. A few lone voices in the wilderness expressed concern over the lack of regulation of these products, and many of these voices were countered by even the Fed Chairman at the time, Alan Greenspan. So when the subprime housing market in the US went up in smoke, taking down the CDOs with them, the calls for regulation of new and unfamiliar products grew louder.
So when the binary options market was deregulated in 2008 to allow for private participation in this otherwise OTC-traded market dominated by institutional investors, there were concerns about the market. Many of these concerns stemmed from the classification of the binary options market as a form of online gambling and so subject to the jurisdiction of gambling commissions as opposed to financial regulators. This opened the door to the entrance of many bucket shop companies and unscrupulous entities who with as little as $20,000, could setup an entire trading engine that could collect money from investors, setup a platform for trading, link with pricing systems and complete with back end offices to handle clearing and settlement of trades. But as anyone familiar with banking operations would tell you, operating as a broker goes well beyond this. Not everyone will cash out at the same time in any market or any bank, so there has to be a financial reserve held by operators of such business to cater to withdrawal requests of traders while waiting for trades to be settled. It is the job of regulators to ensure that the market operators have this financial reserve and ensure it is not tampered with in any way so that traders who want to withdraw profits can get their money and everyone is happy.
Now this is where things started off very wrongly for the binary options market. Here were these guys coming into the market with no financial reserves, no control mechanisms in place, and no one checking on them to make sure that all was going well. It was chaos. These guys were taking money from traders, not fulfilling withdrawal requests, skewing their platforms to screw traders out of their money, and people were losing money all over the place to scammers. Many of these operators found a safe haven in Cyprus because of the investment-friendly conditions that nation presents, and pretty soon, Cyprus no longer came to be known as an investment-friendly nation but as a haven for scam brokers and market operators.
Seeing that the situation was about to create some really bad press for the country and radically affect foreign portfolio investment, the Cypriot regulators stepped and decided to take action. In 2013, binary options were officially classified as a financial instrument by the Cyprus Securities and Exchange Commission (CySEC), citing the Markets in Financial Derivatives (MiFID) protocol. CySEC gave brokers a few months to clean up their act and register as financial brokerage companies with it or pack up and leave. Malta, Japan, Australia and Russia have also followed suit. So we can say clearly that three years down the road, sanity is gradually returning to the market. But there are still lots of challenges, especially with countries that have refused to accord binary options recognition as financial instruments. There are also problems with enforcement in some areas, and in many jurisdictions, punishment for infractions are still to be seen to be too weak to deter the die-hard scammers.
STATE OF REGULATION ON A COUNTRY-BY-COUNTRY BASIS
What is the state of binary options regulation across the world? We now take a look at how the product is regulated across the world so you as a trader can make a decision on where your money should be going.
Regulation of binary options in the United States is the gold standard of the industry. The CFTC has a write-up on its website concerning the regulation of binary options. The regulations are very clear: as an American citizen or a green card holder in America, you cannot deal with any binary options brokers outside of NADEX, Cantor Exchange and CBOE as at 2015. A broker that does not have a license from CFTC is not permitted to solicit US clients and by the law, brokers without a physical presence in the US and who do not offer assets listed and regulated on US exchanges cannot get such a license. It is that simple.
Australia’s binary options market is regulated by the Australian Securities and Investment Commission, which issues the AFSL license to companies offering financial services in Australia. ASIC has been taking a close look at the binary options industry and its regulatory protocols have recently undergone a major makeover. ASIC is now collaborating with the Japanese Financial Services Authority (JFSA) and other regulators from other countries to stop traders from Japan and other countries from opening accounts with Australian brokers. Other changes to the structure of the market are currently being implemented.
The JFSA, which regulates Japan’s binary options market, is now reciprocating Australia’s move and is blocking outsiders from trading binary options with Japanese brokers. The JFSA was the first regulator outside the US to take some far-reaching decisions aimed at protecting the investing public from extreme conditions imposed by brokers on award of bonuses, trade expiry times and general market conditions. Short term expiry trades are now banned in Japan, and brokers are not allowed to use bonuses as marketing tools for prospective traders. Very few brokers are in this market as not many have been able to fulfill the JFSA’s tough conditions for operating a binary options brokerage.
Despite coming out boldly to initiate market regulation in Europe for the first time, CySEC has come under fire for being too lenient with brokerages who contravene sections of the regulatory act. Perhaps in response to these criticisms, CySEC came down hard on Cedar Finance, a binary options broker in Cyprus and had its license suspended.
Canada’s financial market regulatory structure is unique; there is a regional regulator as well as a national regulator. The regional and national regulators have been singing discordant tunes with regards to the status of regulation of the binary options market. As at today, there is no defined regulatory structure for this market.
Russia recently inaugurated a national regulator for the forex market. It is looking at legislation to setup a binary options regulator as well.
The Maltese Financial Services Authority (MFSA) took over regulation of the binary options market from the Gaming Commission following a change of status of the market which officially became a financial market derivative after years of being viewed as a gaming market. The MFSA is one of the first brokers to impose a minimum capital requirement on binary options brokers, which is set to 730,000 Euros.
The United Kingdom’s financial services industry is regulated by the Financial Conduct Authority. The FCA was one of the few regulators who have stood with the policy of segregation of accounts holding clients’ monies. This policy has now been copied by many other regulators following the fall of MF Global, one of the world’s topmost brokerage firms. The investigation of this firm revealed that the company had drawn some money from a segregated account bearing clients’ money in order to cover for shortfalls in its own account as a huge bet placed on the European sovereign debt crisis started to go bad, causing some clients not to receive refunds when the company went into administration. The FCA maintains strict reporting standards and checks on the status of the monies stored in the segregated accounts. This policy is already being tested by the winding down of UK forex brokerage Alpari UK, which went insolvent in January 2015.
Rest of Europe
In most of Europe, binary options are regarded as a gambling operation, which has informed the decision of France and Italy to block offshore binary options companies from soliciting clients within the two countries. The regulators of the financial services industry in France has also gone ahead to secure court orders enabling them to block the IP addresses of offshore companies who attempt to offer binary options products to French citizens. This policy does not look like it will change anytime soon.
It is clear that there is no uniform regulatory practice globally when it comes to binary options. Furthermore, a level of protectionism has entered into the marketplace as Japan and Australia seek to follow the US example of restricting who can trade binary options within their territories. Therefore, today’s binary options traders must be very careful in their broker selection if they wish to get the best out of the market.