NEW YORK U.S. options exchanges, already hard pressed to revive declining volumes, face a new threat from regulatory changes that could restrict the use of options in retirement accounts, which until now have been a growing part of the industry.
The U.S. Department of Labor's (DOL) Conflict of Interest rule aims to stop brokers and advisors from recommending products that put their profits ahead of clients' best interests. The rule, proposed in April 2015, is expected to be published during the first half of this year.
The rule, however, if passed in its current form, would effectively bar the use of options in individual retirement accounts, a growing segment of the industry, market participants say.
"I think the DOL proposal may have been well-intended but unfortunately, some of the consequences and the broad reaching impacts of this rule will have chilling effects on the capital markets and the securities industry," said Andy Nybo, partner and global head of research and consulting at TABB Group, a consultancy.
One tangible impact would be on options trading volume.
U.S. equity options volume has grown rapidly over the last two decades. Annual equity options volume, which in 2000 was at 673 million contracts, has swelled to more than five times that.
But the pace of growth has slowed of late, and for 2015, trading volume fell by about 3 percent compared with 2014.
RETIREMENT ACCOUNTS AT RISK
While it is difficult to estimate the exact extent of the damage, TABB Group estimates that between 2 to 3 percent of overall equity options trading volume occurs in retirement accounts, which could be at risk.
In a bid to protect investors from being unduly influenced to buy inappropriate investments, the proposal expands the definition of a 'fiduciary' under the Employee Retirement Income Security Act (ERISA).
The rule has wide-ranging implications but one aspect that has broker-dealers worried is that brokerages that facilitate trading in listed options would now be held to fiduciary standards.
Being labeled as fiduciary would mean that these broker-dealers can be held to a standard of conduct through a legally binding contract. This new standard could significantly change their revenue and reporting models.
Along with the proposed rule, the DOL has published a list of proposed exemptions that lists types of assets that fiduciaries are permitted to recommend for IRAs. Exchange-traded options are not on the list.
In light of the planned rule and exemptions, broker-dealers may be persuaded to stay away from providing options execution services to retail investors.
The comment period for the proposal closed on Sept. 24 and the draft final rule was sent to the Office of Management and Budget on Jan. 29. The proposal has received thousands of comments from individual investors, investment managers, and other stakeholders. Some of these deal with the use of options in IRAs.
Taking away the ability to trade options would deprive clients of the ability to protect a portfolio or a specific investment, TD Ameritrade Holding said in a written comment in July.
And it's not just brokers and exchanges that are worried. Individual investors have also expressed fears that the rule change could hamper their ability to generate income and reduce risk in their retirement portfolio.
"If the market stays in a range for an extended period of time, my retirement account will be dead money that inflation could erode," said Sean Henderson, a San Antonio, Texas-based retired real estate broker who uses options in his self-directed IRA.
"With options, I can place non-directional trades that make money through time decay," said Henderson, who also provided a comment letter to regulators. "I sure don't want to lose the flexibility that options provide."
(Editing by Bernadette Baum)