Social Trading, Money Managers, Mirrors and Regulation

Earlier in the week we posted on Tradeslide becoming authorized as a money manager as it positions itself in advance

Earlier in the week we posted on Tradeslide becoming authorized as a money manager as it positions itself in advance of potential EU and UK regulation that could affect the auto-trading industry. At issue is whether services that provide retail clients connections to copy trading amounts to portfolio management, as customers have no control on the execution of trades on their behalf.

Combining discretionary and managed trading

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holding handsSimilar to investing in a fund which trades on behalf of its clients, copy trading customers are put in a position where their account is in essence actively managed. However, unlike a mutual or pension fund, which its customer deposits and issues units in the product, copy trading entails the connection of individual accounts which allow their account to be controlled. As such, involved in the trading service are the trade leaders, copy trading platform, and execution broker. Following up the Tradeslide news, Forex Magnates spoke with brokers to receive their take on the matter and the ESMA opinion that was published last year.

Commenting on behalf of eToro, operator of the largest social trading network, Avi Sela, the broker’s COO didn’t provide a specific opinion on the possible framework of regulation. However, Sela explained that they are following the matter as well as ESMA publications to determine how their existing regulation fits as he stated “Following the publication by ESMA, we have consulted with our lawyers and with the relevant regulators to make sure that based on our unique model we do not need to extend our license.” Sela added that operating the network and the brokerage business together provides them flexibility “As eToro performs both the product development and the regulated financial operation, we can respond properly to changes in regulation and when needed, adjust our offering and authorizations accordingly.

Regulatory confusion

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Also responding was Jakub Maly, Retail Division Director at XTB. In addition to its financial regulations in several jurisdictions, XTB also holds a EU money management license which is used to facilitate trading on its xSocial platform. Maly explained that the money management authorization was acquired “based on the strong regulation requirements by our home regulator in order to be able to provide signal trading (provider/follower system) on several markets.” He added that “some countries we operate do not require such licensing, some actually forbid such activity (no matter where the service is physically located), and some of the markets already require such license at this very moment.” In terms of the effects of whether ESMA guidelines will be enforced, Maly stated “once this regulation will be EU wide, enforced (this is very important, regulation without enforcement is not a regulation, but a guideline), and let’s assume it will be enforced, I think we can expect some fatalities.”

In terms of whether regulation for copy trading is even necessary, Maly alluded to unfavorable client practices which take place in the industry which benefit brokers and managers “After all those years in this business, I have seen many interesting client-broker situation, not all of them were nice. Therefore, I tend to believe that the intention of imposing such regulation is actually beneficial for the client.”

Commenting on the technology providers, Maly brought up an important point that any regulation will need to deal with a multitude of factors as large signal and copy trading providers connect traders along multiple jurisdictions and brokers. He stated that “in order for the EU regulation to be effective, it will have to take into consideration the legal connection of the EU brokerage houses with facilitators outside EU, and I am not sure if they have figured this out. The possible outcomes I see are that the EU brokerage houses will not be able to participate in such systems that are based outside the jurisdiction of EU, so (i) either there will be EU based systems, or (ii) they will become EU licenced, or (iii) brokerages will reallocate outside EU if they will see profits in social trading.”

A view from outside the EU

Providing a view from outside the EU, we spoke to Andrew Budzinski, Director at Australian IC Markets, whose business includes many money management (PAMM/MAMM) partners. Budzinski explained that IC Markets requires all offshore money managers to provide a legal opinion or be regulated. In terms of where regulation is head, he stated that currently laws are “still very loose.” He added that “we are obviously seeing some companies set a standard. There will likely be a trickle on effect with more signal / social trading companies becoming regulated.”

Overall, copy trading remains a gray area within the markets. On one hand it holds elements of portfolio management, with clients having their accounts linked and their performance managed by others. On the other hand, retail customers have more say in choosing strategies and often can close positions in mid-trade. As such, it won’t be surprising if we see similar rulings from regulators that include policies to ensure a reduction of conflict of interest issues, but continue to empower clients.

(Image courtesy of Lumaxart)

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