Times have changed since the Cyprus Securities and Exchange Commission (CySEC), who previously had been perceived as the accommodating regulator, astonished the trading industry last November, when it put out its circular that included significant restrictions on forex and CFD trading brokerages.
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A number of the restrictions outlined by the Cypriot watchdog included pulling the plug on attracting clients with high bonuses, allowing clients to withdraw funds on the same day that a request is made, and a significant limitation on leverage ratios.
What was happening until then?
Prior to these more stringent regulations being approved, there is no question that the industry’s reputation was quickly dwindling into disrepute. The regulator itself was seen as being too soft, with no teeth in which to confer a sense of protection for traders.
Yet at the same time, CySEC appeared reluctant to make its regulations more stringent. Taking the hard line could in effect make brokerage businesses unprofitable, which could cost the Cypriot money in lost streams of tax and business revenue – the situation of bonuses replicated an arms race.
Brokers competed aggressively against one another to offer the highest bonuses. They were used as a tool to incentivize retail traders to trade complex speculative products, such as binary options, CFDs and rolling spot forex on their respective platforms.
However, this technique of drawing in clients took the emphasis away from actual trading conditions, as well as the quality of customer service and fees. Many novice traders who had little loyalty for the brokerage that they would do business with would simply hop from one broker to the next in an ongoing pursuit of the bigger bonus, playing little heed to actual trading conditions.
Yet bigger bonuses never actually guaranteed, or at least achieved, better results for traders. Whilst for brokers the technique may have won them a trade, it didn’t win them a client for the long term. The situation on leverage was not much better, as it was not unusual for brokers to offer as much as 1:1000 leverage and in some cases as high as 1:2000.
Indeed, brokers also offered astronomical leverage rates in a bid to attract new clients with the promise of making wins at these massive windfall rates. However, the promise for enormous wins also carried the risk of dramatic losses and many traders hit the wall when their margin calls were not sufficient in covering their devastating losses.
How are these restrictions going to affect retail brokers?
According to Constantina Economidou, the Cypriot Head of Compliance at Leverate: “Bonuses have always been a fundamental business component for almost all brokers, especially small brokers who have limited other means for which to be competitive.”
“Bonuses made the market more competitive for getting new clients in the door, with exorbitant bonuses schemes, that sometimes amounted to their total deposits.”
Economidou anticipates that now that the bank of bonuses is no longer available, brokers will have to re-evaluate their marketing strategies to focus on long-term solutions that favor their clients’ interests.
For some brokers this has meant shifting their focus to a reduction of spreads and commissions, while others have focused their attention on offering a wider suite of instruments. Small brokers that heavily depended on being able to offer big bonuses will be the hardest hit, for their resources are likely to be more limited in what they can otherwise offer their clients.
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Has CySEC simply punished the good guys who were at least regulated?
While these more stringent regulations may ultimately have a positive impact on the industry for the long term, the immediate result has been a spike in the number of established non-regulated brokers.
Many of those critical of these recent changes have claimed that CySEC, despite its good intentions, is effectively only penalizing regulated brokers who in the very least were regulated. Instead, CySEC should have doubled down on its efforts on unregulated brokers who are ultimately causing the most damage to the industry.
Economidou disagreed with this premise, but maintained that the push to tighten regulation came from the top, rather than a reaction to activities happening on the ground. “ESMA, the financial authority for the EU, set in motion these additional restrictions and that is why we have seen stricter measures in other EU countries such as Belgium, Germany, UK, Poland and so on, all in the last few months.”
The objective for ESMA was to establish a more transparent and stable financial market, especially for retail clients who do not have the necessary wealth of experience to draw on to protect their assets. As ESMA assessed the risk for traders, the granting of bonuses, which practically leads to higher leverage and risk, inevitably came up as a major issue. Therefore the ban on bonuses was primarily born out of ESMA’s assessment of the financial trading industry.
Yet, aside from bonuses, ESMA also identified the need to address issues related to traders’ withdrawal of their funds. Economidou explained that in the past she has seen all too many traders be manipulated by brokers who either do not process withdrawal requests at all or advise clients that they must perform certain trading requirements for their withdrawal to be processed.
In order to address this issue, CySEC now requires that if a client is in a positive cash balance a brokerage service under their auspices must process a client’s request to withdraw funds on the same day, or if the request is made after business hours, then the funds are to be released on the following business day.
In relation to leverage, the recent changes in regulation have entailed a full backflip in industry practices. Brokers are now required to design their trading system so that clients are offered as a default the lowest leverage rate and only on the client’s initiative are they able to select a higher leverage ratio.
Yet even at its maximum rate, leverage is not able to exceed 1:25 for traders with less than 12 months of experience and 1:50 for even for the most experienced trader. Until now, a huge amount of revenue could be made on just one trade, but as this is no longer feasible, brokers will be looking to increase the frequency of their clients trades, particular through social trading which is conducive to trading small amounts at rapid speeds.
Brokers will now be looking how to make the best of the change in leverage caps, either by adjusting their payment structures so that their revenue is generated through client trading costs or by looking at other forms of incentives within the new guidelines.
According to Nicc Lewis, CMO of Leverate: “Brokers will be looking at how they approach conversion and retention in a new way. A broker can promote themselves as being ‘Client First’, with a business model that educates clients about markets, products and associated risks and genuinely positions their traders to win.”
“As with any restrictions there are always new creative approaches, but at the end of the day having a seal of approval from a recognized regulator is a positive message for traders and an asset to brokers towards building long term trust relations,” he explained.
Will CySEC achieve its objective of preserving the trading industry?
For Economidou, this change in regulation has been a long time coming: “CySEC is on its way to implement what is understood to be required under EU Law. But simultaneously, CySEC also wishes to gain its place among the strong forex regulators, thereby making itself attractive not only to brokers but also to traders wishing to invest within a more trustworthy and prestigious framework.”
The brokers that are able to survive this turbulent period of transition and meet these key changes will eventually be able to attract more traders. As the industry’s reputation improves, investors will feel more secure about funding their capital through legitimate and transparent brokers.
This article was written by Adinah Brown, Content Manager at Leverate.