Will ESMA Guidelines Refer to COVID-19?

The European Securities and Markets Authority (ESMA) was founded on January 1st, 2011. It replaced the Committee of European Securities Regulations (CESR). The main aim of this organization is to regulate and ensure the effective functioning of the European financial markets, while at the same time protecting the rights of investors.

So the obvious question is, how can it have an impact on the Foreign exchange market? Well, one of the problems traders face is negative balances on trading accounts, where potentially an individual can lose more than the initial investment.

For most Forex traders it is essential to limit potential losses to their total amount of deposit. If for example, a trader deposits only $10,000, then for him or her this might be the amount they can afford to lose. The last thing they want is to be charged more than they have deposited.

To address those concerns and protect the interests of retail clients, the European Securities and Markets Authority issued a regulation, which requires brokers to offer negative balance protection on a per-account basis. The new rules also limited the maximum leverage at 1:30 and also banned the marketing, sale, and distribution of binary options.

During recent years, the powers and responsibilities of this institution expanded significantly. For example,  According to the BBC, in 2012 the EU gave the European Securities and Markets Authority power to ban short-selling if it threatened the stability and security of the EU financial system.

So how could ESMA respond to the disruptions caused by COVID-19 pandemic? Well, recently the European Securities and Markets Authority, prepared a new web page about COVID-19 which might offer some answers on this issue.

Latest ESMA Measures in Response to COVID-19 Pandemic

According to its website, In response to the COVID-19 outbreak, the European Securities and Markets Authority has intensified the coordination with National Competent Authorities, also offering them much needed relief on such deadlines as Securities Financing Transaction reporting, while at the same time coordinating the implementations of the new short selling measures in several member states.

At the beginning of April, the European Securities and Markets Authority also updated its risk assessment for European Union financial markets. According to this report, the main risk drivers are the worsening of the macroeconomic environment, as well as political and event risks. The assessment also warns us about the possible infrastructure disruptions and rising risks in the public and private debt markets.

Furthermore, ESMA tries to not focus its gaze too much on financial service providers such as investment companies. But, we know for a fact that the recent pandemic had a tremendous effect on the markets, thus prompting thousands of traders to take action. ESMA is very likely to expand policies for brokers that offer negative balance protection to their customers. The risk at which people trade currently is more than doubled as opposed to “normal economic times”.

Finally, the report makes a note of the fact that there was a massive correction on the equity market in the middle of February 2020 and ESMA sees a prolonged period of elevated risk for both institutional and private investors.

In response to those challenges, ESMA issues several guidelines. On March 24th the European Securities and Markets Authority issued new guidance on accounting implications of the COVID-19 outbreak. Another document was issued 3 days later, which discusses financial reporting deadlines during the pandemic.

However, one of the most important steps ESMA took was the implementation of short selling measures. A new rule requires the holders of short positions to notify local National Competent Authorities in case if their positions reach or exceed 0.1% of the share capital of a given security. It is also mentioned that this measure is temporary, so depending upon the situation this might be canceled at some point in the future.

This decision might give us hint, that instead of outright banning short selling, the ESMA might be preparing the ground to put some limit on this activity and by this measure reduce potential downside for the European Equity markets.

The official ESMA webpage concedes that there is some increase in the short-selling positions, however so far there is no indication that this disrupts the proper functioning of the Market. The statement concludes by saying that ESMA will continue to monitor developments and take the appropriate measures if necessary.

Obviously it is difficult to come up with 100% accurate predictions about the possible regulatory changes, however we can make several observations.

Firstly, it seems like that so far ESMA is most concerned about the Equity and Bond markets, so far the short-selling measures have been relatively mild, however, if situations worsen considerably, like if we have a EU stock market collapse or a renewed Sovereign debt crisis, then this institutions might take much stricter measures against the short selling.

However, in this case, most likely those restrictions will be applied towards the Equity and Bond markets since those are the ones they are concerned about. Unless there is some serious calamity, European Forex traders should be able to take short and long positions on currency pairs without any limitations.