The European Securities and Markets Authority (ESMA ), the European Union's financial markets regulatory and oversight body, has released a statement addressing concerns over investor protection related to fractional shares.

ESMA Speaks about Fractional Shares Protection Concerns

Tuesday's announcement emphasizes that "derivatives on a fraction of shares are" not equivalent to corporate shares, and as such, companies should not use the term "fractional shares" when promoting these products. In compliance with the obligation to enable clients to comprehend the nature and risks of specific financial instruments reasonably, companies must clarify to investors that they are purchasing a derivative product.

"All information provided to clients on these instruments shall be fair, clear, and not misleading and that firms must clearly disclosed all direct and indirect costs and charges relating to them," ESMA wrote in a press release.

Moreover, ESMA's statement reminds regulated businesses that these products are intricate and are, therefore, not suitable for all customers, but only for a narrow audience, and require an adequacy assessment when providing services to retail investors.

"As derivatives on fractions of shares are not corporate shares, firms should not use the term fractional shares when referring to these instruments. ESMA would deem such use of the term misleading and therefore in breach of MiFID II requirements," the supervisor added.

Companies presenting these derivatives must transparently reveal all direct and indirect expenses and fees associated with the products and services rendered. This encompasses the structuring and other costs integrated within fractional shares, in addition to mark-ups and mark-downs, proportionately compared to the market value of the corresponding corporate share.

ESMA defines 'fractional share' as an instrument enabling investors to partake in a company's performance through a tool that follows the share price while being accessible at a lower acquisition cost, precisely the proportionate stock price of the underlying share. Typically, it grants investors the financial advantages of dividend payouts, but generally, it does not come with voting privileges.

As a result of the above, ESMA wants firms offering to trade on these specific derivatives to introduce a number of additional measures to protect retail investors, explaining exactly what they are, how much they cost, how they are managed and who they are aimed at.

Fractional Shares Flooded the Retail Market

The idea behind investing in fractional shares is simple. If an investor cannot afford to buy the entire stock of a relatively expensive company like Tesla or Apple, he can make a purchase of only part of it for the capital he has. Such offerings became extremely popular during the pandemic era, when retail trading was booming, and trading apps were gaining massive interest.

As early as the beginning of 2020, fractional shares and ETF offerings were presented by Fidelity Investments, a US broker with 23 million clients at the time. However, the first offerings of this type had already begun to appear a few months earlier, thanks to Interactive Brokers and Charles Schwab, among others, as a response to the increasingly strong competition in the US market from Robinhood. The popular app, which started the massive trend of commission-free trading, joined the new industry fad in late 2019.

During the Covid-19 pandemic, commission-free trading on fractional shares was introduced, among others, by FXCM and in the following months, companies such as Skilling and BUX joined the trend.

The FMA flags CFDs broker and AI in portfolio management, read today's news nuggets.