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Regulation of Malta Binary Options
On the 17th July 2013, the Malta Financial Services Authority (MFSA) announced that Binary Options are considered as instruments falling within the parameters of the Second Schedule of the Investment Services Act. This announcement follows a clarification made by the European Commission that Binary Options meet the requirements prescribed in the definition of financial instruments in point (4) of Section C of Annex 1 to the MiFID (Directive 2004/39/EC), given that they are derivative contracts settled in cash. In fact, the list in the directive covers derivatives relating to commodities that are settled in cash or that can be physically settled provided they have the characteristics of other derivative financial instruments.
Malta Binary Options: Gaming or trading?
Binary options originated as a gaming product, and prior to the MFSA announcement, companies offering financial services such as forex trading in Malta were regulated under the Maltese Lotteries and Gaming Authority (LGA), whose aim is to regulate the gaming industry. This reflected the uncertainty created by the dichotomy in the regulatory framework adopted by different EU countries in relation to Binary Options. Whilst CySEC, the Cypriot regulator CySEC, which recognized binary options as a tradable financial instrument in 2012, binary options were regulated by the UK Gaming Commission as ‘bets’, thus not being enforceable in UK courts.
However, this decision by the European Commission has brought about a radical change in the Binary Options market since they are being considered as an alternative to standard forex trading. This has attracted the attention financial regulatory authorities around the world, including the MFSA, which has embarked on a project to define the parameters by which Malta Binary Options would be regulated on the financial markets.
Definition of Malta Binary Options
In the MFSA communication, Binary Options are defined as being contracts based on the direction which the price of an underlying asset will take within a specified time frame. Thus Binary Options are derivative contracts with only two possible outcomes that depend on whether the forecast price is correct (in-the-money) or incorrect (out-of-the-money).
Binary Options Trading Companies offer their clients a platform where they can trade binary options in several underlying products, such as oil, gold, indices, currencies, and stocks amongst others. Binary options constitute private contracts between the client and the Binary Options Trading Company which are settled in cash. Clients are able to speculate on which direction the price of an underlying product will move within a specified time frame. A fixed amount of cash will be paid to the Client if the option expires in-the-money; however, if at the end of the time frame the option expires out-of-the-money, the client would lose his entire, or part of, the investment.
Different types of Binary Options
There are various types of Binary Options, however, further clarity by the MFSA is still required to ascertain whether all the potential variants would be captured by the definition highlighted above. The most common types of Binary Options are the following:
Call/Put Binary Option
The Call/Put Binary Option consists of an automatically generated strike price and the trader’s objective would be to guess whether the price of the underlying asset will end above or below this price when the option expires. The trade is In-The-Money if the trader guesses the correct direction, whilst it is considered Out-Of-The-Money if the guess is wrong.
60 Seconds Binary Option
The 60 Seconds Binary Option is similar to the Call/Put binary option, however, the option expires one minute after the position is opened. This binary option is more suitable for traders who seek dynamic trading that brings immediate results. This type of binary option is the most problematic to classify as a financial instrument since it is very similar to a gambling activity.
One Touch Binary Option
In the case of One Touch Binary Options, the trader has to predict whether the asset price will touch at least once the predefined price mark during the lifespan of the particular Touch option. This is a rather high-risk type of trade, but the payouts often get over 500%.
Boundary Binary Option
On the other hand, the Boundary Binary Option, also known as In/Out binary option, the asset price has to stay within certain boundaries which are defined by two strike prices – upper and lower. A positive outcome will be attained if the price finishes within the upper and lower prices at the expiration time, irrespective of the number of times that the price leaves the boundaries during the trade.
Licence Requirement for Malta Binary Options Companies
The MFSA’s proposal to assume responsibility for Binary Options in place of the LGA is important news for the industry, and the Maltese regulator will expand its own regulatory framework to ensure that investors are not misled by disreputable companies and guarantee that investors enjoy higher protection. Any person intending to provide investment services relating to Malta Binary Options, as well as companies currently licensed by the LGA, would need to submit to the normal licence application procedure as well as an extensive due diligence process to obtain an Investment Services Category 3 licence in terms of the Investment Services Act. Licence holders would be able to avail themselves of the passporting rules under MiFID so as to operate anywhere within the EU without the need for further licensing. In the case of entities which are already in possession of a category 3 investment services licence, they would need to notify the MFSA in writing as to whether they intend to conduct binary options activities or whether they already perform such activities.
The licensing process entails three phases, in the same way as an application for regulation for other financial services providers which fall under the jurisdiction of the MFSA. First there is the preparatory stage, followed by the pre-licensing stage, and finally the post-licensing and commencement of business stage. The duration of the licensing process depends on the completeness of the documentation and efficiency of the applicant, and normally takes between three to six months. The Binary Options broker must comply with three essential requirements outlined in the Investment Services Act, that is:
- to ensure the protection of investors and the general public;
- to safeguard the reputation of Malta in line with Malta’s international commitments;
- to enhance competition and choice.
Brokers licensed to sell Binary Options in Malta must adhere to a minimum capital requirement of €730,000 and will be subject to both on-site and off-site compliance. This would constitute a further layer of investor protection and ensure that brokers can fulfill their obligations towards their clients. Furthermore, every company that intends to offer Malta Binary Options is bound to establish physical premises in Malta.
Benefits of becoming a licensed a Malta Binary Options Brokers
- Regulated Binary options brokers will be subject to on-going monitoring by the MFSA, ensuring an adequate level of transparency and investor protection. In the case of breach of any regulation, the MFSA could issue strict warnings and fines, and the broker would risk losing its licence in case of a serious violation.
- The constant monitoring by the financial services regulatory authority will ensure that binary options brokers maintain the requisite standards to ensure fair practice and transparent pricing.
- Clients’ funds are kept in a segregated bank account to ensure the safety of their funds.
- Binary options traders licensed under the MiFID regime will benefit from passporting rights under the directive, greatly reducing regulatory costs.
Why Binary Options are becoming increasingly popular – advantages of Binary Options over traditional Options
- Binary options tend to be simpler to trade since only a sense of direction of the price movement of the underlying asset is required. The magnitude of the price movement is irrelevant.
- There is a controlled risk to reward ratio, which are pre-determined when the contract is concluded, unlike traditional options where gains and losses can be limitless. The investor is presented with the amount he/she stands to win and the amount you stand to lose prior to any investment, enhancing transparency.
- One does not require large amounts of money to trade in binary options, but can invest small amounts of money at a time.
- The payout amount is not proportional to the amount by which the option ends up in-the-money – the winner will receive the entire fixed payoff amount even if the Binary option settles in-the-money by just one tick.
- Binary options tend to be of short duration, thus providing the trader with several flexible investment opportunities, yielding high rewards and fast returns.
- It is possible to trade in a wide variety of assets across multiple markets in a manner which suits the particular investor.
- An investor can make money not only when prices are rising, but also when prices slope downwards.
- Many trade platforms can also be accessed via a mobile phone, enabling an investor to trade on the move and check options regularly and conveniently, twenty-four hours a day.
Binary options are a recent financial innovation and many investors are still reluctant to invest in binary options due to concerns about the regulatory and security issues. There is hardly any legal framework at the disposal of financial regulators, and in fact, it is only recently that the drafting of a regulatory framework to regulate binary options has started to gain momentum.
MFSA’s regulatory acceptance of binary options and its effort to develop a comprehensive online trading regulatory framework will play a crucial role in attracting online trading firms to set up a base for their operations in Malta. Malta already boasts a number of attractive features that have led numerous businesses to choose it as their domicile (such as approachable regulators, low set-up costs, an educated English speaking workforce and sound IT infrastructure), and this new development will inevitably make the jurisdiction more attractive for binary options businesses.