ESMA considering regulation of social trading
The European Securities and Markets Authority (ESMA), the EU’s securities markets regulator, has released a statement to highlight to retail investors the risks connected with trading decisions based exclusively on exchanges of views, informal recommendations and sharing of trading intentions through social networks and unregulated online platforms – or as we call it for short, social trading.
The statement was issued as part of ESMA’s investor protection objective to safeguard retail investors.
ESMA stated that several recent episodes have seen certain US stocks experience high price volatility based on information shared on social media. Although market rules and structures are different in the European Union, the regulator stated that it cannot be ruled out that similar circumstances may develop in the EU. And it is clear that ESMA wants to work to prevent that from happening.
The announcement from ESMA comes two months after we exclusively reported that Australia’s financial regulator ASIC was also investigating copy trading, a form of social trading. The ASIC review, although not official, was prompted by an episode whereby about 1,200 young Australians, some in their teens, were caught up in a copy trading disaster when a trader “leader” they were following went rogue and wiped out their investments in 48 hours.
The US events ESMA refers to were much different than the copy trading incident in Australia. A very large group of retail traders, sharing views on Reddit “Wallstreetbets”, ended up initiating short squeezes in a number of heavily shorted US stocks such as GameStop and AMC Entertainment in late January and early February. The social-driven action caused huge losses to (primarily) large institutional investors who had large short positions, but the wild up-and-then-back-down short squeeze play also drew in a large number of unprepared retail traders looking to make a quick buck. Some did, but some also lost big. The market craziness also caught a lot of brokers unprepared, some of which limited trading in certain stocks while others simply stopped taking on new clients for a while.
The ESMA statement highlights the following issues:
❑ Investors need to use reliable information for investment decisions;
❑ Increased risk of investor loss due to price volatility; and
❑ Risk of committing market abuse.
ESMA said that alongside the EU’s various national financial regulators it will continue analysing market events and consider adopting further initiatives aimed at preserving investor protection and market integrity as appropriate.
Social trading has been around in various forms for as long as social networking has been with us (anyone remember Currensee?), but has really just taken off lately. Some FX and CFD brokers have made social trading a mainstay of their offerings, with some very good results being seen by firms such as eToro and NAGA.com.
The full statement issued by ESMA reads as follows:
17 February 2021
STATEMENT
Episodes of very high volatility in trading of certain stocks
Recent episodes have shown very high volatility in certain US stocks, linked to a significant accumulation of net short positions and concerted action by some retail investors, based on information shared on social media.
Although market rules and structures are different in the EU, it cannot be ruled out that similar circumstances may occur in the EU as well.
An increased participation of retail investors in stock markets is welcome for the development of the Capital Markets Union. Nonetheless, ESMA urges retail investors to be careful when taking investment decisions based exclusively on information from social media and other unregulated online platforms, if they cannot verify the reliability and quality of that information.
A key step for any investor before making an investment decision is to gather investment information from reliable sources, while keeping in mind one’s investment objectives, the benefits of diversification and the ability to bear losses.
Price volatility increases investors’ risk of loss Retail investors face significant risks when investing in stocks characterised by very high price volatility. Volatility could be increased by many factors including when stocks are subject to heavy short selling. Price trends can suddenly come to a halt and reverse, quickly exposing retail clients to heavy losses.
Those using trading strategies that involve leverage are exposed to even greater risks as leverage increases investor’s exposure to potential losses. Examples are day-trading strategies in which margin trading, i.e. trading with money borrowed from the firm, or derivatives are used. ESMA stresses that trading with leverage is complex and should be entered into with a full understanding of the risks.
Market abuse risks
Discussing the opportunity to buy or sell the shares of an issuer does not constitute market abuse. However, organising or executing coordinated strategies to trade or place orders at certain conditions and times to move a share’s price could constitute market manipulation.
Similarly, special care should be taken when posting information on social media about an issuer or a financial instrument, as disseminating false or misleading information may also be market manipulation. Additionally, care should be taken when disseminating investment recommendations through any media, including social media and online platforms, as they are subject to a number of regulatory requirements.
ESMA and the National Competent Authorities will continue analysing market events and consider adopting further initiatives aimed at preserving investor protection and market integrity as appropriate.
Anonymous
February 18, 2021 @ 5:51 pm
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