ESMA Leverage: Impact On Traders, Investors And DARWINs

26 June 2018
Jesús Domínguez

The following post complements the article ESMA – Product Intervention published a few months ago in our blog and aims to provide all the details of the impending regulatory change, as well as the impact of ESMA leverage on traders, investors and DARWINs.

ESMA’s new regulations are just around the corner, so we suppose that, whether a trader or an investor, you’ll be wondering how this regulatory change will impact your trading/investing.


New ESMA Maximum Leverage (As Of August 1st)

Before going forward, let me remind you of the new maximum leverage that will be effective as of August 1 to help you grasp the impact of these new measures.

esma leverage impact on traders


How does ESMA affect DARWIN investors?

As we described in our previous article, the impact of ESMA regulations on investors is almost negligible*, since the new limit imposed by ESMA is above the level of leverage employed by DARWINs (DARWINs target VaR => 10% per month).

*A DARWIN’s volatility might decreases temporarily if its trader currently trades with a leverage much higher than the one required by the ESMA. However, it will NEVER occur that a DARWIN volatility rises due to ESMA regulation.


How does ESMA affect traders and their grades in the Investable Attributes?

Here we are faced with two possible cases.

  1. A trader who trades with less leverage than the maximum required by ESMA. If you are within the group of traders that do not exceed the maximum leverage imposed by ESMA, this change does not affect you at all.
  2. A trader that trades with leverage levels above the maximum required by ESMA. Should this be your case, you need to be aware that, from August 1st onwards, you will not be able to keep on trading with the same lot size as you’ve been doing up to now and this may affect your trading, as well as your Risk stability Investable Attribute (Rs) grade.

The greater the difference between your current leverage and ESMA’s leverage limit, the higher the impact on your Rs grade

What does the Rs Investable Attribute assess?

The Rs Attribute measures how stable the DARWIN’s underlying strategy’s risk is. The higher the score, the more stable the risk, hence: 1) the more proportional the DARWIN’s behaviour vs. its underlying strategy, and 2) the more likely the DARWIN will trade with a 10% VaR target risk.

Possible worsening in your Rs grade

If due to ESMA leverage, the VaR of your strategy decreases rapidly, the Rs grade will deteriorate temporarily until it finds a new area of support at your new risk level.

Example

Imagine that you were currently trading with a 60:1 leverage in forex majors and your monthly VaR were around 40%, that is, four times higher than your DARWIN.

As of August 1st, ESMA will only allow you a maximum leverage of 30:1 – half your current leverage-, so if you decide not to take any preventive measure before this date, the VaR of your strategy will decrease until it consolidates around 20% -half leverage = half VaR-.

If your VaR falls from 40% to 20% swiftly, your Rs grade will deteriorate for a few weeks until it finds its new “comfort zone” around 20%.

What happens if your Rs grade gets worse?

The first consequence will be a worsening in your D-Score grade. As a consequence, your DARWIN might lose attractiveness for both our investors and our proprietary investment algorithms.

How can you avoid a decline in your Rs / D-score grade?

To avoid a sudden decrease in your risk level and, in case you want to maintain the current lot size, we highly recommend that you increase the equity in your trading account based on the ratio between the ESMA leverage and your current leverage level.

Increase Equity = Current Leverage / ESMA Leverage

Continuing with the previous example, if you had a 2000 € account and were currently trading in majors with a 60:1 leverage and, should you like to continue trading with the same lot size, you’d have to double the equity of that account:

Equity increase: 60/30 = 2

Important: add capital gradually

It is very important that you start adding capital gradually as soon as possible to adapt your trading strategy during the weeks before the implementation of the new ESMA leverage.

To do this, we ask you to calculate the remaining days / weeks until August 1st and gradually add, until July 31st, the capital you have to deposit to prevent your grade in the Rs Attribute from deteriorating.

  • Market days / weeks until August 1st (for the sake of the example, imagine that today is Monday, July 2nd, 2018) => 22 days / four weeks and two days
  • Capital to add=> 2000 €

Amount of capital to transfer capital from your wallet to your MetaTrader account = total capital to deposit / days (or weeks)

  • Daily deposit: 2000/22 => 90.90 €
  • Weekly deposit => 2000/4 => 500 €*

*The more you get to fraction your deposits the smoother your VaR curve will decrease and the less it’ll affect your Rs grade.


With this article, we hope we’ve been able to dispel all your doubts that could have arisen about the new ESMA regulation.