BINArY OPTIONS: The licensing Debate

R Paul Davis, LL.D. 1

Introduction example, the trader might put money on the table and Attendees at any of the world’s major gaming or speculate that a stock will rise to a specifi c value by, affi liate shows (ICE, EIG, LAC) cannot have failed say 3 pm today. Either it does, or it doesn’t. If it does, to notice the proliferation over the last two years the counterparty or operator pays out up to 85% of of fi nancially based operators, including “Forex2 ” the original stake and returns the stake money. If it but mainly binary options companies. Some of the doesn’t, most or all of the stake or investment is lost. tradeshow stands have been spectacular and the Of course, as with all mature fi nancial products, there apparent marketing budgets are impressive. At the are many and subtle variations on the basic product. last LAC3 – London Affi liates Conference, a rough One popular variant is the “one touch” binary option, R Paul Davis impression is that half the stand space was devoted to where the trader bets not on the fi nal result at a these products; they arguably had the most striking defi ned time, but on whether the price of the subject stands and boasted some of the best-turned-out commodity will touch a certain price before the representatives. expiry of a period of time. One touch, and the trader Despite the pervasive presence of binary options is paid out; no touch by the end of the period, and operators in the gaming marketplace, however, the stake is lost. In sum, though, the underlying asset leading fi gures in the industry proclaim strongly that or commodity is never owned or delivered by any binary options are not “gambling” products at all, party to the transaction; there is merely a fi nancial but “fi nancial services” Consumers of the product relationship based on market prices. are referred to as “traders” while the technology Trading in binary options is thus a form of companies call themselves “platforms” and the fi nancial gambling, and in that simple statement lies operators “brokers.” Th is portraiture in the fi nancial the million dollar question. Is it gambling, or is it services mode has profound implications for licensing fi nancial trading? It’s possible to argue that longer practices and consideration of the legality of off erings. term plays are fi nancial investments, because some Around the world, governments and regulators are skill is involved in predicting the future of a market taking diverse approaches; the end game remains (just like a stock, currency or commodity). Of course, obscure in several jurisdictions. As a prelude to the skill can be involved in some activities which no-one live debate to be held at the IMGL Conference in Oslo, disputes are gambling, such as betting on the outcome the following will set the scene and summarize the of a sporting event. Indeed, outside of the on-line current position. entertainment environment, there is a legitimate place for binary options in the commercial world What are “binary options?” as an instrument for hedging future positions of Binary options aren’t new. Th ey were invented as commodities or currencies. Very short term options, an investment product around 1908, in Chicago, however, look more like gambling because, as prices but the mathematical calculations surrounding move in a zigzag pattern and not a straight line, what them were developed in the 1970s. Th e most happens in the next minute or fi ve is an unpredictable, notable mathematician and scholar involved was uncontrollable event. In terms of trader experience, by Myron Scholes, a Canadian, who won a Nobel too, there is a marked contrast between, for example, a Prize for his work. CFO calmly purchasing an option to expire at the end “Binary,” because there are only two results of the year to hedge a currency position, and a private possible for the trader’s prediction (wrong or right) individual sitting down to place a stake on 15 minutes on a market movement; “0” or 1 “1” in computer language. For Group General Counsel, Th e Counting House Group of Companies, Suite 3, 3rd Floor, Britannia House, St Georges St, Douglas, Isle of Man. [email protected] 2 Traditionally “Foreign Exchange” refers to the commercial activity of exchanging one currency for another. However, “forex trading” which bears some similarity with “day trading” on the stock market, has become a popular form of internet speculation where amounts are staked on the direction of movement between two currencies, rather than the actual exchange of one currency for another. Th ere is close 26 | European Gaming Lawyer | Autumn Issue | 2013 intertwining of the “forex” world with that of binary options, with many companies off ering both products. of movement and gaining a similar adrenalin marketplace has made regulation, with “(4) Options, futures, swaps, forward rush to watching a horse race or a football the attendant marketing opportunity, an rate agreements and any other derivative match with money staked on the result. attractive haven for many operators. The contracts relating to securities, currencies, Binary options are traded on stocks, jurisdictions of choice for licensing have interest rates or yields, or other derivative options and futures markets (for example, the clearly debated, and in some cases struggled instruments, financial indices or financial Chicago Board Options Exchange and Amex with, the distinction, with varying results as measures which may be settled physically or – The American Stock Exchange4 ) and are explained below. in cash.” seen in many places as financial instruments. However, there are two much more From the point of view of operators However, they’ve been popularized in the last subtle and compelling reasons why binary within the EU, this looks like a slam dunk, couple of years by some very aggressive, very options operators really, deeply want to be clear end to the debate. Binary options fit clever, mainly Israeli enterprises, largely using considered purveyors of financial products. this definition squarely, and the force of Cyprus-based companies. Aside of a handful The first relates to payment card processing. MiFID then comes to bear; firms offering of independents, the supplier marketplace If a binary option is a gamble, then the all- binary options to the public are required to consists of five major “platforms” – software important MCC – Merchant Category Code be authorized and regulated in their home providers who have turnkey solutions for – assigned by the card schemes6 is 7995. This state (the state where their registered office offering binary trading on the web. These is a restrictive code blocked by many issuing is located). This is a departure from the have the best part of 300 “white labels” banks, particularly in countries like Norway previous situation under the ISD where – essentially risk-taking marketing B2C and the USA, where internet gambling is regulation was required where the activity companies who promote the software of the largely or wholly illegal. If however the took place. From the point of view of an platforms on branded sites around the world, deposit transaction when a trader funds his operator with branches in several countries usually in return for a setup fee and a profit account is a financial investment, then the it is a welcome improvement, for it opens share. The largest binary options platform, merchant is able to apply for use of MCC up the possibility of passporting the SpotOption, claims to support 65-70% of the 6211, “Security Brokers/Dealers” or even authorization throughout the EU and EEA. world market. All five major Israeli platforms 6051, “Non-FI Money Orders.” The relative Within the EU, implementation of MiFID are well funded, professionally run, and have likelihood of approval for a transaction in respect of binaries is at different stages. massive transactional volumes. However, even for a country where gambling is legal, Elsewhere however, different approaches the majority of operators using them are such as Spain, is significantly higher; in have been taken. Here follows a review presently unregulated, meaning there is no countries where gambling is prohibited and of the situation in some of the principal protection of investor funds and no market payments methods are targeted as a means jurisdictions where serious consideration oversight of their offerings and practices. of control, the difference is between virtually has been given to the issue. The options are traded “over-the-counter,” guaranteed failure of a transaction, and a direct from seller to buyer, and the customer strong possibility of success. Cyprus requires little or no knowledge to participate. Secondly, religious, cultural and Cyprus has the distinction of having been Naturally the operators attempt to offer their legislative differences open or close a first mover in this area, and arguably of “odds” on an algorithmic basis so that they markets for the operators. Binary Options having the clearest legislation on the issue. show a net gain for each day’s trading. are popular in the Arab states, where Binary options, beyond doubt, are financial The financial problems of Cyprus have gambling is illegal under secular and instruments in Cyprus, and regulated caused both platforms and operators (“white religious laws. Binary companies are keen to accordingly. All Cypriot firms offering labels”) to re-think their dependence on offer their services in the lucrative markets binary options are required to bring their the country, its banks, and importantly its of Saudi Arabia, Qatar, the Emirates and activities within the ambit of the regulator licensing authority (CySec5 ). Increasingly others, but can only do so if they are offering alongside other investment company they are looking towards Malta, the Isle financial services. Obviously construed as requirements. What has however muddied of Man, and possibly other places, for a gambling product, taking customers for the waters considerable is the establishment their global regulation and credibility, binary options would be difficult at best and of a series of delaying and grandfathering while engaging in discussion with largely impossible when considering the provisions, which have essentially allowed regulators regarding national licensing. payment aspect. Cyprus firms to continue offering binary This is remarkably similar to the gaming options while their applications for licence environment of today, and begs the question How have different jurisdictions issue or modification are pending. At the as to which body, where gambling and approached the problem? time of writing most Cyprus operators who financial services are licensed by different The starting point for consideration have applied for licences are “in limbo” authorities, should issue the licence and be in a European context is of course pending determination of their applications, the regulator. MiFID. Section C of Appendix I sets but are freely permitted to continue to offer out a list of “Financial Instruments” products despite the not-yet-determined Why is the distinction important? and, while it does not mention binary status of their licence applications. A Cyprus Competition in the binary options options by name, includes: licence remains a valuable prize, despite the economic difficulties of the country, 3 London Affiliates Conference, 7-10 February 2013, http://www.igbaffiliate.com/events/ londonaffiliateconference/schedule 4 Where they are referred to as “Fixed Return Options.” 5 Cyprus Securities and Exchange Commission. 6 Visa and Mastercard, principally. American Express does not permit gambling transactions to be paid for European Gaming Lawyer | Autumn Issue | 2013 | 27 using its cards.. because Cyprus is an EU country but with that there is no notion of criminality Maltese environment, are now Financial relatively liberal compliance and taxation is evident in the physical presence of Instruments. Malta is likely to emerge as requirements; however, there is massive representative offices of major platforms a significant base for Israeli-owned binary unwillingness to place money with Cyprus such as SpotOption. Were there any fear of enterprises, as it has the attractions, not to banks and this is a heavy disincentive. The prosecution no doubt the offshore operators be under-rated, of a warm climate, relative regulatory deposit requirement has been would stay physically away from Tokyo real proximity to Tel Aviv, an English-speaking clarified to reduce this disincentive, and estate! However, legislators and regulators population, and a large gaming sector with licensees can hold their collateral outside are aware of the growing presence of the customer service experience. The capital the country; however, the ability to act as product and serious review is under way requirements for investment companies a broker while the application is pending by two bodies, the governmental Japan in Malta are by contrast likely to be a means that many brokers have incurred Financial Services Agency (JFSA) and the disincentive for smaller brokers. the relatively low cost of applying, but self-regulatory body the Financial Futures may not actually proceed to full licensing Association of Japan (FFAJ). Speculation in Turkey which is more expensive and burdensome. the Japanese press and elsewhere is that a Turkey has been a popular market for The situation remains changeable and framework has already been agreed, and that binary options operators, being a country unsatisfactory. rule changes are likely to forbid certain types where most forms of gambling are strictly of options. Most significantly, very short controlled and limited to government Isle of Man term and high/low type options are likely monopolies. The irony of Turkey’s In this prominent jurisdiction for gaming to be prohibited, as the authorities see these aspirations to EU membership coupled regulation, two brokers have applied more as gambling than financial activities. with its stark opposition to private sector successfully for gambling licences under Summer of 2013 was set last year as a gambling is noteworthy. Historically, Forex OGRA and are up, running, and enjoying target date for completion of the regulatory trading has attracted the attention of the success as regulated gaming operators. exercise, though at the time of writing Turkish Capital Markets Board (“CMB”) That is not the end of the story, however, as there has been no announcement. Leading and from August 2011 local licensing was the banking and governmental difficulties representatives of the industry have been required for all brokers. Since then the in Cyprus have sent many Cypriot-based engaged in continuous consultation with the number of licences granted to Turkish Forex brokers looking for a more stable licensing drafters and movement is expected soon. companies has reached into double figures, jurisdiction. Several have approached the Isle The effect of such regulation is likely but around two dozen foreign operators of Man with a desire to move their operations to be twofold: first, it is likely to cause a departed or switched to binary options, and take licenses from the Financial significant reduction in volumes traded believing that binaries would be of limited Supervision Commission. An initial rejection and profitability for brokers; second, it is interest to CMB. Not so, in mid-2012 the of these overtures by the FSC, apparently likely to perpetuate a black market in the regulator issued a bulletin in which it largely on the basis that it didn’t have the most popular types which afford the best accused unlicensed brokers of criminal resources to regulate binary options, has adrenalin rush for traders! activity and required internet service turned into a protracted discussion about a providers to shut down several IP addresses possible hybrid approach where FSC issues Malta related to binary sites. Implicit in the CMB’s licences, but the GSC with its knowledge of Binary options in Malta have undergone ruling is the notion that it does not consider the marketplace and procedures provides a transformation from gambling to binary options to be financial instruments regulatory supervision on a sub-contract Financial Services. In the wake of the but rather gambling products. At least two basis. This is a novel approach but one which Cypriot crisis, considerable interest Turkish brokers appear to have shut down could pay huge dividends for the island as was shown by many firms in moving since, although foreign based operators still hundreds of jobs could quickly move there. their operations and licensing to Malta. appear keen to offer products into Turkey if Previously subject to licensing by the they can solve the payments issues. Japan Lotteries and Gaming Authority, on Japan is of major interest to this debate. 18th July 2013 the Maltese Financial The United States It is the world’s most avid consumer of Services Authority announced that it was It’s easy to make the bold statement that Forex products on the internet, with some taking the view that binary options fell binary options trading is legal in the USA commentators suggesting that there are under MiFID and that it would seek to - just like driving a car, if you have the more domestic Forex traders in Japan than licence and regulate operators under the required licence and equipment! Futures the entire rest of the world. Despite lower Investment Services Category 3 licensing have been regulated at a federal level in the limits, it is probably true that the net volume regime. An agreement was made to US for over one and a half centuries, and of Forex trades in Japan exceeds all other transfer responsibility for existing LGA the body with official oversight is the US countries combined. operators over to the MFSA and work is Commodity Futures Trading Commission. Binary options trading in Japan is under way. Binary options, which once The CFTC has issued a licence, for presently unregulated, and a demonstration appeared to be gambling products in the example, to NADEX (the North American

28 | European Gaming Lawyer | Autumn Issue | 2013 Derivatives Exchange) to deal in, inter alia, Financial Services sector, and the Isle of Man publicly offered binary options trading. Of binary options. looks poised to move strongly in the same course, those of us working in the criminal It is one thing to have official exchanges direction. MiFID appears clear on the issues, law sphere, either side of the fence, will brokering derivative type instruments Japan and the United States are in no doubt, probably also have plenty of opportunities to between individuals. However, the real and in other smaller countries legislative prosecute or defend the cowboys, for there questions relate to over-the-counter control has come from the financial sector. will always be a Wild West in any rapidly offerings, and offshore operators selling But are they right? In poker, there is a moving internet environment. into US markets. There is no doubt as strong argument that traditional forms are The over-riding consideration must be, to the federal government’s position on games of skill. Some variants, however, of course, consumer protection. There can unlicensed offshore operators; in June 2013 appear to have no element of skill and could be no argument that in the longer term, both the Securities Exchange Commission be construed as pure games of chance, where regulation is a desirable outcome for all and CFTC took legal action against a large the player has no element of control and jurisdictions in order that the public be Cyprus-based operator, Banc de Binary. no amount of skill can affect the outcome. protected from sharp practice, paucity The regulators filed civil suits in Nevada, Could the same be said for binary options, of information, misleading claims and charging violation of prohibitions on where longer term plays fit settled notions mishandling of client monies. off-exchange options trading, and illegal of investment but shorter term speculation Lastly, we should return to the prime operation of an unregistered futures looks like a pure gamble? Is trader behaviour interests of the platforms and brokers. merchant. The penalties sought are an indicator of which side of the line the Clearly it’s in their best interests to be seen monetary and injunctive. This followed product falls? Certainly the very short as financial services, and to be licensed as similar actions against Irish operator InTrade (one minute) plays and the widespread such, for the reasons laid out above. The at the end of 2012; subsequently InTrade availability of over-the-counter binary world of payments, however, seems to be appears to have gone completely out of options has moved the clientele from the somewhat behind the curve at the moment. business. financial community to the entertainment The Risk Management team at FirstData, It is interesting to note that the US arena. Is there value in the “one size fits which has a massive presence in the gaming government has not taken any stance that all” designation of binary options as either world, has recently declared an interest in binary options are gambling products; the gambling or financial, or should there be participating in card processing for binary implication is that with appropriate licensing consequences from the conclusion that some options, and has expressed a preference for in place, the SEC and CFTC are entirely forms fit one definition while others are best dealing with licensed operators. Yet, despite happy for these instruments to be offered viewed as gambling products? If so, who is to the majority of licensing activity being in to the public. From this it can be concluded draw the line and who is to regulate? the financial services sector, it has also ruled that US legislators are content that they Just as, in the sports betting world, in-play that for the time being, all transactions must are Financial Instruments. This is further betting with its shorter time frames and fast be coded 7995 (the gambling code). Such underlined by absence of the DOJ from the resolutions has become highly popular with restrictive policy with the major brokers above proceedings; there is no allegation of the public and the operators, shorter term leaves emerging businesses at the mercy of criminality and no reference to gambling binary options find great favour with brokers less scrupulous acquirers and, in extreme legislation. The situation remains analogous because they allow faster churn of greater circumstances, might even lead them to to that in the online gambling industry, amounts of money. The dilution of skill mis-coding of transactions through a grey where indictments have been preferred content coupled with algorithmic offering area acquirer. It further exposes them to very against a handful of major operators while allows for greater profitability. A long term high pricing (but 90% of $100 is better than approximately 3,000 sites remain available binary option purchase looks like a stock 98.5% of nothing). Our profession can play a to the American public. For binary options, market investment. A short term binary leading role in arguing the appropriate best two major enforcement actions are under option purchase looks a lot like an in-play practices for both industry participants and way while Americans continue to have bet. How is the world of binary options to be their payment product providers. access to over 100 offshore providers. regulated in the long term, or is it a passing fad that will recede into the background In Summary when the “next big thing” arrives to consume By a show of hands, the world is moving the passions of internet gamblers? The inexorably in the direction of voting author offers, with humility, the suggestion r Paul Davis is the Managing binary options to be financial instruments. that regulation from either sector is a good Director of Counting House Turkey stands somewhat alone in seeking and necessary evolution for the marketplace (IOM) Ltd., a payments and cash to criminalize their offering as gambling as a whole, and that the legal profession management consultancy based products; the Isle of Man and Malta have has a great deal to offer in understanding in Douglas, Isle of Man. Comments historically granted licences in the gaming the proposition, guiding the brokers and correspondence welcome: environment, but Malta has turned 180 and platforms towards a fully regulated [email protected] degrees to assume all responsibility in the environment, and ensuring the maturity of

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