With the London Summit less than three months away, Finance Magnates sat down with some of the event’s speakers to get a sense of what’s in store for attendees. In this piece, we focus on the recent changes to the FX retail market.
Of course, any changes in 2018 obviously are focused on regulation, with the space seeing its biggest shakeup in years. With ESMA’s newest restrictions coming into effect this month, the brokerage industry has had to adapt accordingly. By extension, we can expect the FCA to continue to address speculative products.
Is this just the tip of the iceberg or will the industry be able to settle into for a new norm? Christian Rolando, Managing Director of Lugano Associates gives his take in a brief interview.
What is your position and what does your role entail?
I left the FCA last year to set up a consultancy firm called Lugano Associates, which focuses on providing risk, governance and compliance consulting services to UK based FX & CFD providers.
This sector has seen extensive regulatory scrutiny over the last few years, culminating in material rule changes. As a result, much of my time is currently being spent advising Boards and Senior Management on how to enhance their control framework and adapt to these changes.
I have also been providing support and strategic advice during contentious regulatory matters and coordinating engagement with the FCA with a view to avoiding Enforcement action.
What is the single most important market event or development in 2018 so far?
Without a doubt ESMA’s product intervention measures to restrict the sale, marketing, and distribution of CFDs to retail clients, which came into force on August 1, 2018, throughout the EU. These changes include a substantial reduction in leverage limits with a maximum of 30:1 for major currency pairs; negative balance protection and margin close out rules on a per account basis; and a restriction on the use of incentives to trade CFDs.
Whilst there was extensive consultation and discussion about these policy measures throughout 2017, their formal adoption marks a significant step towards an uncertain future for the industry which could lead to consolidation and changes in market share.
What are the biggest challenges that the FX trading community is facing? How do they affect your field?
The introduction of Negative Balance Protection has already had a significant impact on the sector because many firms have been relying on the ‘matched-principal exemption’ meaning they cannot face material market risk exposure.
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By offering these accounts, firms are increasing their exposure to the extent that client loses exceed account equity and may therefore be operating outside of their regulatory permissions. A quick look back at Alpari’s model shows how critical this impact can be. As a result, the FCA has received a large number of applications from firms looking to move to a full-scope license.
Others have implemented alternative strategies to remain in compliance, such as obtaining negative balance protection from their liquidity providers. However, they will need to be careful about how this is managed and consider the capital impact of such a strategy.
How does the FCA view leveraged trading five years from now?
The FCA has been clear that it considers leveraged trading to be a ‘high-risk speculative investment’ and intends to limit its accessibility to the average retail consumer. Whilst there is value in offering these products to a certain type of investor, until recently a large proportion of ‘inappropriate’ individuals have been allowed to take part.
One of the regulator’s main objectives is to secure an appropriate degree of protection for consumers. With such a large proportion of clients losing money, the FCA was forced to take action and consider whether these products should continue to be allowed. Over time, the FCA would expect to see a much stronger culture within the retail FX and CFD sector, with a distinct focus on customer outcomes.
The introduction of a firm-specific risk warning, where firms must disclose the percentage of retail client losses, is expected to go some way to encourage firms to consider client outcomes at a senior level.
So far, have UK clients opted for focusing on professional traders or looking for new jurisdictions? Which?
Without being too specific, there seems to be a mix between firms looking to enhance their product offering to attract Professional Traders and those looking to maintain their existing model by onboarding clients outside of the EU.
It is too early to tell which is the right move, but it seems likely that over time non-EU authorities will take steps to tighten regulation so I don’t see an attempt to find new jurisdictions as a long-term solution.
It is clear that many clients prefer to deal through the UK due to various protections such as the FSCS and the FOS. The FCA has previously expressed concern with firm’s attempting to obtain an ‘FCA badge’ to use for marketing purposes or to increase client numbers. Time will tell whether clients place a higher value on leverage than consumer protection.
However, this also applies to firms looking to re-classify retail clients as professional. Whilst in certain circumstances this might be appropriate, we should expect to see fines, restrictions and enforcement action in due course for firms that have not managed this process properly.
Christian Rolando will be speaking at the upcoming 2018 London Summit about regulation in the EU region and beyond. Learn more and register here today!