Exclusive: Regulators Conducted Preliminary Reviews on Potential Prop Trading Regulations

The increasing popularity of trader-funded firms, marketed as prop trading firms, has attracted the attention of regulators. An industry source told Finance Magnates that the European Securities and Markets Authority (ESMA) recently ran an initial check on such prop trading firms and also discussed possible regulations in the industry. However, the pan-European regulator refused to confirm its possible move towards prop trading regulations.

Further, Remonda Kirketerp-Møller, founder and CEO at the regulatory compliance firm Muinmos, confirmed to Finance Magnates that “regulators have been conducting studies, gathering data, and engaging in consultations with industry participants to better understand the nature and implications of prop trading.”

Currently, prop trading companies only have to follow laws such as consumer protection rules, data protection rules, and conditions for international sanctions. The registration of such companies is concentrated in the US, the UK, the UAE, and Saint Vincent and the Grenadines. Yet, many are registered within the EU.

"Some jurisdictions have implemented certain regulatory measures or guidelines to oversee prop trading activities within their markets," Kirketerp-Møller added. However, proper regulatory measures are yet to come.

The Approach of Regulators

Regulatory interest in prop trading surfaced with the Commodity Futures Trading Commission's (CFTC) and its Canadian counterpart's lawsuit against My Forex Funds last year. However, those were limited to only enforcement levels.

In March, Belgium’s regulator, the Financial Services and Markets Authority (FSMA), issued a warning against prop trading, calling it a “game of shadow investing, a practice that costs money and can lead to reckless behaviour.” Notably, Belgium is the only country in the European Union that has banned the offering of contracts for differences (CFDs) instruments to retail traders.

However, none of the other regulators have made any public statements about prop trading and the possibility of regulations. FTMO, one of the popular prop trading brands, also confirmed that the company was not approached by any regulator “to discuss future regulation of the industry.”

However, when regulators prepare for regulations, they usually consult industry players. "When CFDs regulation was introduced in Israel, Leverate actively participated in the process," said Ran Strauss, CEO of Leverate, a technology provider in the financial services space.

“Some regulators don't believe in the model (of prop trading), some want to ban the model, some believe the model will die off,” a long-term industry insider told Finance Magnates. “We should expect some clarity towards the end of this year.”

When Finance Magnates approached the ESMA, it refused to confirm the discussion on the prop trading regulations, saying: “The meeting dates of ESMA meetings are not published, nor are the agendas of these meetings. So we cannot comment on anything else on this.”

However, many industry participants are still anticipating a regulatory push on prop trading. Evdokia Pitsillidou, Risk & Compliance Director at SALVUS Funds, said: “On a European level, regulators are anticipated to introduce requirements for proprietary trading firms, including authorisation under the Markets in Financial Instruments Directive (MiFID), subject to the investment service of Dealing on Own Account.”

"This expectation stems from the understanding that certain aspects of prop trading may fall within this investment service category. This could entail firms needing this designation to offer services to clients, even for activities such as collecting subscriptions for demo trading. The aim is to ensure that firms are subject to organizational and operational requirements, enhancing transparency and investor protection within the prop trading sector."

The nature of the prop trading model has also created confusion about who should regulate this industry.

“Regulation will definitely come, but it’s unclear when, how, and from whom,” Devexperts’ CEO, Evgeny Sorokin, highlighted. “Rules around prop firm operations could be better suited to the gaming and gambling industry legislation rather than financial.”

The Dilemma of Prop Trading Regulations

Prop trading firms do not handle clients’ monies for trading or offer brokerage services. So, the existing regulations on retail over-the-counter derivatives brokers do not apply to them. Furthermore, most of the prop trading activities—from challenges to trading with funded accounts—are conducted on demo accounts.

Due to the unregulated nature of the prop trading businesses, hundreds, if not more, of brands have spawned over the past few years. While some have established their name, many face complaints, mostly around denied payouts.

“Currently, prop trading is a little like the Wild West with very few industry regulations,” Greg Rubin, Head of Axi Select, told Finance Magnates. “Most players in this space use demo accounts and charge a registration fee to participate. They ultimately structure the offering to be virtual and non-financial, and therefore not subject to financial regulations.”

"This means that most of the firms would likely not even complete the most basic client checks such as the AML or KYC on clients."

This is the first part of our two-part series on prop trading regulations. The upcoming second part will portray what industry experts think about how the possible prop trading regulations would look like. Stay tuned!