Winds of Change: Russian Retail Traders Flood Offshore as Regulation Bites

Brokers inability to hedge against client trades has caused an exodus in the Russian retail market

With all of the buzz surrounding the European Securities and Markets Authority’s (ESMA) most recent exploits, regulatory news concerning other jurisdictions has been pushed to the side over the past couple of months.

ESMA is not the only regulatory body making life tough for brokers across the globe. This Tuesday, the Russian Association of Forex Dealers (AFD) noted that regulation in the world’s largest country is forcing traders to open accounts with offshore brokers.

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At a press conference this Tuesday in the city of Yekaterinburg, almost a thousand miles east of Moscow, Evgeny Masharov, the head of the AFD, called for regulatory change. He claimed that only 1.75 percent of all forex traders in Russia use brokers that have the local authorities’ approval.

Generally one should take demands from groups such as the AFD with a pinch of salt. After all, the organization is made up of FX brokers who may be inclined to put their interests, and not necessarily their clients’ needs, first.

In this case, however, Masharov seems to have a completely legitimate point. To understand why that is, it’s worth briefly looking at the situation of brokers in Russia and the legislation they must adhere to.

No Hedging, Minimum Leverage

In 2014, Russian president Vladimir Putin signed the country’s Forex Law. As the above sub-heading suggests, this brought about a number of significant changes to the Russian FX brokerage industry.

Evgeny Mashov
Evgeny Mashov, Head of the AFD

Firstly, brokers are now only able to offer leveraged trading of 50:1 to retail clients. That’s more than the maximum 30:1 leverage that ESMA’s regulation permits but it still puts a damper on brokers’ plans.

The reason for this is fairly straightforward; clients want high leverage. One of the main appeals of FX trading for retail clients, rightly or wrongly, is the ability to trade with huge sums of money that would otherwise be beyond their means.

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Perhaps more significant than the cap on leverage, brokers are not permitted to hedge against the positions taken by their clients. That means brokers cannot resend orders to market, to a liquidity provider for example, and are forced to take the positions opposite to their clients.

That makes for a particularly unappealing proposition for any prospective client. If a broker has to take positions against its clients, then it is impossible for the broker to have the client’s interests at heart. This is because, in this scenario, the client’s loss is the broker’s gain and vice versa.

Heading Offshore

Just by reading the above regulations, one could deduce that Russian retail traders would head offshore. The extent to which they have is still somewhat surprising. Indeed, it could be viewed as a testament to how informed Russian traders are – they aren’t foolish enough to use brokers whose interests are diametrically opposed to theirs.

As noted, 1.75 percent of Russian retail traders use offshore brokers. That means, that of 400,000 retail traders, only 7000 trade with the eight brokers that have, thus far, received the stamp of Russian regulatory approval.

Amusingly, many of those traders are using the sister companies of brokers that are registered in Russia. Alpari, for example, will get Russian clients via its local website but then get users to sign contracts with one of its offshore, sister brokers.

Wrongheaded Regulation

All of this illustrates why Masharov was right to call for regulatory change. In Tuesday’s press conference he asked that regulators enable brokers to start hedging against their clients’ positions.

That doesn’t seem partisan but entirely reasonable. Rather than protecting clients, as it was supposed to do, Russia’s current FX regulation is pushing clients to offshore brokers, many of which are unlikely to offer any sort of client protection.

The reason for this is that traders, rightly, don’t want to use brokers that are trading against them. Were that law to change, we would likely see a large number of Russian traders starting to use domestic brokers. Whether that will happen is unclear – we’ll just have to hope President Putin is a Finance Magnates reader.

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