The Australian Minister for Revenue and Financial Services, Hon Kelly O’Dwyer has communicated that the Australian government is proceeding with reforms to the retail over-the-counter foreign exchange and CFDs sector that is going to dramatically impact the local industry.
The reforms which the government says are designed to protect clients, could cause operation difficulties for a number of companies in the country. The companies that are holding a regulatory license from the Australian Securities and Investments Commission (ASIC) will no longer be able to use client money “for a wide range of purposes, including for working capital”.
The government states in its official announcement on the matter that the use of client money for certain activities is not permitted in a number of G20 economies.
Commenting on the announcement, the Director of financial services consultancy Sophie Grace, Sophie Gerber, stated, “There’s around 55 licensees in the OTC derivatives sector according to ASIC Report 482. Without being able to see the annual FS70 and FS71 (i.e. financial statements) of each of these companies (i.e. everyone that is a Pty Ltd), it is impossible to know if they are all adequately capitalized to cope with these client money reforms, i.e. that they have sufficient capital to hedge their client positions where they consider it necessary.”
“However given ASIC’s comments in Report 482 on the poor level of NTA compliance, I’m concerned that most entities are not in a position to withstand these changes. This will potentially lead to unfortunate insolvency issues over the next couple of years to the severe detriment of clients or many AFSL sales before the rules come into force as smaller players seek to exit the industry,” Ms Gerber explained.”
How to be an STP Broker When Client Funds Can’t be Used for Working Capital?
The announcement does not come as a surprise since the Australian government has released a draft Bill in February 2016, that has addressed the issue of client money handling. The proposal appears to have been implemented without thorough examination of the operating processes in the industry, since the new regulatory regime is likely to favor market makers over STP brokers.
Commenting on today’s announcement the General Manager of transaction reporting focused Fintech company TRAction and former managing director of AxiTrader, Quinn Perrott, said, “I think the big winners here are large brokers that are already running a B book as this effectively puts pressure on smaller less sophisticated brokers and also less capitalised brokers. It also puts another obstacle to entry on the industry (as if there wasn’t enough already). In my opinion, the big losers of the day are Prime of Prime (PoP) firms and fully straight through processing (STP) brokers. PoP brokers will find their clients (often smaller STP firms) don’t have enough of their own capital to cover margin and will probably be forced to adopt a B book model.”
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“Fully STP brokers will find hedging too capital intensive without the use of client funds and the return on capital often won’t be worth the risk. For retail clients, in general I see this as neutral. I think there are a few cases in the past where it could have saved clients from losses but there are also plenty of examples where it would have made no difference. Even with client money staying in trust there is plenty of room for error, poor accounting or outright fraud. Also this legislation may reduce competition and severely limit the STP model, neither being good for the retail client. Basically this was a win for IG markets and CMC, who went to great lengths to try and stifle competition,” Mr Perrot explains.
Ms Gerber elaborated on the matter, “Some applicants are being afforded an opportunity to meet with the regulator to discuss their proposed business model and operations, whereas others are being outright ignored for months on end and then finally rejected (often with ill-conceived reasoning, however the process to refute these decisions is very time-consuming). I’d like to see ASIC start facilitating a flow-through of investment in this industry as well as others so we can all benefit.”
While the government claims that the ban on the use of client money for working capital is designed to ensure the safekeeping of clients’ funds, companies that are willing to transmit their clients’ order on to the broad marketplace will have to warrant their positions with the broker’s own finds.
“I hope alongside this that ASIC will solidify its position on its review and approval of AFSLs which has, as everyone knows, been most difficult in the past few years, with no proper guidance being released by ASIC, rather it being done in an ad hoc and inefficient way to various industry players as they see fit,” the Director of Financial Services consultancy Sophie Grace elaborated.
One Year Grace Period
Australian authorities will give a one year term to all companies to begin complying with the new regulatory framework. While no official timeline has been provided, the new Bill mandating the client funds regulations will be introduced at the earliest opportunity to enhance consumer protection.
In an official announcement, the Australian authorities have stated, “The Government has conducted extensive consultation on the proposed regime, with almost 50 submissions received on the discussion paper and draft Bill. In addition, numerous consultation the government meetings have been held with a broad range of stakeholders, including industry associations, the Australian Securities and Investments Commission and the ASX.”
“While the Government acknowledges that the Bill may cause some disruption to firms that use a particular business model, the Government’s primary objective is to ensure the protection of retail client monies, and these reforms will achieve this objective,” the official statement reads.
While it is understandable that the Australian government is willing to protect consumers from losing access to their funds, the new regulation is likely to exclude Australian retail investors from the STP market.