Winds of change are blowing through the European Union (EU). And for those in the financial world, the perfect storm has arrived.

The European Securities and Markets Authority (ESMA) is making sweeping regulatory changes that are being hailed as a single rule book for EU financial markets. The authority is aiming to improve investor protection while supervising all financial entities with a tighter rein.

ESMA has been working since 2011 to fix many of the issues that arose from the 2007 Global Financial Crisis (GFC). Its new regulations are far-reaching and will affect everything from credit ratings to shadow banking.

On the surface this seems like a sensible thing to do, if a little late in the day.

The good guys and bad guys of finance

The whole finance industry seems to have become one big game of cops and robbers. The bankers and hedge funds, companies that are designed to make money, have been branded as the ‘bad guys’. These companies are said to have acted irresponsibly to create the GFC. The implication is that they need to be controlled and punished with regulation.

However, as a society, we may have to take some responsibility ourselves. Were we ever forced into investing our money? These companies existed to service our demand. And what about the ‘good guys’ – the governments and central banks?

We are a decade on the from the credit crunch, and the European Central Bank has printed hundreds of billions of euros as part of huge quantitative easing programmes and kept interest rates ultra-low – all in the hope of stimulating growth. But the current figures, such as the EU gross domestic product (GDP), don’t make encouraging reading for such a massive investment. But they’re just doing their job, right? They don’t have to be accountable for their failings.

As investors, we have to decide what’s more dangerous for the global economy: companies trying to make money, or governments literally printing money? Every call is easy in hindsight, but regulation can’t always fix what may happen in the future.

A lot of ‘too little, too late’ is coming from the same people who created the conditions for a crash to happen in the first place.

Traders get caught in the net

Now, I’m not your typical investor. I’m a trader. Although some of the language used is the same, the mentality of an investor and a trader are quite different.

This brings me to why I’m writing about the EMSA regulations.

The problem with such sweeping regulation is that it’s not always the bad guys and the corporations that get targeted. Part of the new ESMA regulations specifically targets the average man on the street – the everyday trader.

In the new rules, particular attention has been paid to the world of spread betting and contract for difference (CFD). This is where investors can take a short-term view on the various global markets and make ‘buy’ or ‘sell’ trades without ever acquiring the assets.

The principle decided upon by ESMA was made that ordinary investors should not be allowed to trade large amounts of leverage. Leverage is where for every $1 of your own money you trade within the markets, a broker would provide you with leverage and in some cases allow you to trade up to 500 times that amount.

After the regulation changes came into effect (on 1 August), the average retail trader in the EU can now only access a maximum of only 30:1 leverage. If they wish to trade at the same level they previously enjoyed, they’ll have to put up the money to cover the difference in margin. The maths is pretty simple: They’ll need more capital to fund a less leveraged account.

Who will be affected?

The impact in the EU will be immediate. The ESMA changes will simply end the trading opportunity for 80 per cent of the small-account traders out there.

Some people will be able to fund larger accounts to manage their investments. Others will trade outside the EU or trade via countries like New Zealand.

Now, most people reading this will say, so what? It doesn’t affect me. I don’t trade.

Ask yourself this. Why do the regulatory bodies want to stop ordinary investors being able to trade the markets with leverage?

Using other people’s money

What do you think the professionals trade with? Not their own money. They trade with leverage, backed by money deposited by you and me. This is another shift of power back to the 1 per cent – the corporations.

Every single day, more than US$4 trillion is traded on the foreign-exchange markets. Just think of that sum of money.

Leverage gave the average person enough meaningful size to trade the markets. This opportunity is now gone for them, but it remains for the ‘bad guys’.

If you live in New Zealand, this isn’t the case. You can easily start spread-betting and trade today. You can get up to 500:1 leverage and you can trade the markets.

You may not be interested in trading, but are you interested in leveraging your capital? In my experience, people always want to do things when they’re told they no longer can.

Definitions

Contract for difference: A contractual agreement between two parties, where one party pays the other party the difference between the current price of an asset and the price at a date in the contract. The direction of price movement determines the payee.

Gross domestic product (GDP): GDP is a measure of a country’s market value. It covers all goods and services produced within a timeframe and can be used to compare nations.

Hedge fund: An aggressively managed fund that may trade often or invest with complex strategies, including techniques taking advantage of both rises and falls in markets.

Leverage: The use of borrowed capital as a funding source to increase the potential return on an investment.

Quantitative easing: A monetary policy used by central banks and governments to stimulate their economy, often through the purchase of government bonds and increase in the supply of money.

Shadow banking: Non-bank unregulated financial institutions, providing credit and capital to borrowers and investors.

Spread betting: Speculation on the movement in price of an asset, without actually owning it.

View JUNO's full list of definitions here.

First published 20 August, 2018.

Story by Steve Ruffley

JUNO does not contain financial advice as defined by the Financial Advisers Act 2008. Consult a suitably qualified financial adviser before making investment decisions. This story reflects the views of the contributor only. Content comes from sources that JUNO considers accurate, but we do not guarantee that the content is accurate.