The UK financial regulator, the Financial Conduct Authority, is considering a series of steps that could prove to be very challenging for a big part of the London-based FX industry. According to sources with knowledge of the matter, the watchdog has distributed a letter to a number of UK-based brokers to inform them of prospective changes to the regulatory environment.
According to the letter, the FCA is considering forcing straight-through processing (STP) brokers to upgrade their licenses to those of full market makers. This is necessary to ensure that the companies manage to cover negative balances resulting from prospective client losses due to unexpected market moves.
STP brokers in the UK have been considered by some officials as poorly capitalized to cover negative balances of their clients. To remind our readers, Alpari UK was one of the first victims of the post-SNB crisis that resulted in losses that were way over $1 billion for the FX industry. The total costs of the coverage of negative balances for STP brokers could exceed their capital base in the case of another unexpected black swan event, according to the regulator’s thinking.
The UK regulator’s measures are giving brokers two courses of action – either to comply and upgrade their licenses to IFPRU 730K, from the existing IFPRU 125K and possibly some IFPRU 50K firms, or give up on-boarding retail clients.
Variation of Permission
The changes were communicated to brokerages right after the official publication of the new regulations that are being discussed for retail brokerages. One of the key reasons for the move is said to be the capital base of STP brokerages. Their balance sheets have not been deemed large enough to cover negative balances of clients. Since the no-negative equity requirement is a virtual certainty in the new regulatory environment, so is the ability of firms to adhere to it.
It is not known whether many firms that are currently operating on an STP basis will be able to afford to implement a variation of their permissions. Covering market risks has been an issue for several bankrupt companies in the UK: Alpari UK, Boston Prime, and Liquid Markets.
Regulated firms are rumored to need to implement new capital monitoring mechanisms and the FCA is likely to have more say in determining the capital requirements for brokers. According to the thinking of the FCA, some companies’ capital reserves are not reflective of the actual market risk that they are holding.
Currently, every FCA brokerage is bound to different capital requirements, based on the number and type of its clients.