Reed Smith In-depth

On February 17, 2022, the German Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin) made available for consultation a proposed general ruling on futures with margin requirements – a measure that would fall under article 42 of Regulation (EU) No. 600/2014 of the European Parliament and of the Council of May 15, 2014 on markets in financial instruments and amending Regulation (EU) No. 648/2012 (MiFIR).

With the general ruling, BaFin intends to prohibit securities trading companies from marketing, distributing and selling futures with margin calls to retail investors.

Authors: Friedrich Lutter

How futures work

Futures are standardized forward contracts on, among other things, financial instruments and commodities. They contain a contractual obligation to deliver (short position) or take delivery (long position) of a specified quantity of an underlying asset (contract item) at a price fixed at the time the contract is concluded and at a later date, which is also agreed at the time the contract is concluded.

Requirements for trading in futures

In order to trade in futures, trading participants must deposit collateral with the futures exchange in the form of a capital contribution (margin) to ensure future fulfillment of the concluded transaction. The amount of collateral is determined by the futures exchange and is generally based on the risk or volatility of the underlying asset under the futures contract.

In addition to the minimum capital contribution (initial margin), a certain margin account amount is set by the futures exchange. This amount may never fall short of the maintenance margin, which is the minimum limit for the amount of collateral to be provided by retail investors and is set slightly below the initial margin. If this limit is not met, the investor receives a margin call to replenish the account. If this does not happen, the broker closes the position by closing out the contract. This is called a forced liquidation or forced closure.

An obligation to make additional contributions, so called “margin call”, arises if the collateral paid in by the investor is insufficient to compensate for losses incurred after a forced closure has taken place and the investor therefore has to compensate for these losses from other funds.

In the past, especially in the case of exceptional market events (so-called “black swan” events), significant price fluctuations have confounded the expectations of investors and resulted in high additional funding obligations.

The amount of any loss compensation under an obligation to make additional contributions is not limited to the original amount, and may be much higher.

Restrictions on margin calls already in force

Already, on May 8, 2017, BaFin had banned the distribution of CFDs with margin calls to retail customers in Germany after significant margin call obligations arose in January 2015 in connection with the “Swiss Franc Crash.”

With a general ruling dated July 23, 2019, BaFin restricted so-called contracts for difference (CFDs), which may now only be marketed to retail investors under certain conditions, for example, if it can be ensured that investors do not have to make any additional margin payments and any loss is limited to the amount invested (so-called “negative balance protection”).

Furthermore, statutory exclusions apply to additional funding obligations in Germany. For example, asset investments with an obligation to make additional contributions are prohibited under section 5b (1) of the German Asset Investment Act (Vermögensanlagengesetz). Section 152 (1) of the German Investment Code (Kapitalanlagegesetzbuch) also excludes any obligation for limited partners of limited investment partnerships to make additional contributions.