Following last week’s announcement by Cypriot financial markets regulator CySEC outlining new regulatory rulings that would require prior authorization to be granted by regulatory authorities in non-EU jurisdictions should a Cyprus-based FX or binary options company seek to solicit business outside the EU, a number of questions and potential adaptations of business models are being discussed within the industry.
Gabriel Styllas, CEO of TopFX today provided Forex Magnates with his perspective, as his firm provides prime of prime brokerage solutions to a number of companies in Cyprus. “The CIFs that do have physical presence and / or actively soliciting clients in third country jurisdictions, immediately need to obtain authorization from competent local authorities or get legal advice that authorization is not required, in order to be in compliance with CySec legislation” stated Mr. Styllas.
He believes that the resultant effect will cause the onboarding of future clients from outside the EU to become more difficult for CySEC regulated FX and binary options firms.
Mr. Styllas is not unduly concerned that firms will withdraw their business from Cyprus in full: “I don’t expect CIFs will revoke their own licenses and opt for an FCA license instead, as CySEC’s rulings are based on the MiFID directive which applies to all EU countries, creating the same situation if a firm chooses to be based in London.”
“In addition this ruling does not apply to companies that do not have a physical presence and are not actively soliciting clients, for example CIFs can still accept professional clients from third countries who are contacting them on their own initiative because let’s say CIF has an established reputation as a liquidity provider” concluded Mr. Styllas.
Further clarification of matters for consideration and how navigate the ruling was provided by Archer Consultants’ CEO Lior Shmuely.
Archer Consultants is a professional services company which assists FX and binary options brokerages to establish their operations in a number of jurisdictions, including New Zealand, Australia, Cyprus and the UK, along with providing consultancy services with relation to gaining regulation.
Speaking on the events that led up to CySEC proposing to implement this ruling, Mr. Shmuely today explained to Forex Magnates that “The concept of this is not new. It has been unofficial policy for around 3 years. A Cypriot company doesn’t break laws by taking a non-EU client. It’s the country of the client’s origin which is outside Europe where the illegality lies.”
“For example, for a brokerage to accept Japanese clients, the brokerage must be regulated by the Japanese FSA. Japan has no jurisdiction over Cyprus, therefore it cannot apply its own regulatory rulings to a trading account held by a Japanese citizen with a Cypriot company.”
“Because of this, the Japanese FSA has made some complaints to CySEC, some of them as long ago as two years ago, regarding the conduct of firms regulated by CySEC. The complaints dictate that there are strict regulations in Japan, and the method of operating which the Cyprus firms are offering would generally differ from Japanese law, therefore Japanese FSA prefers such companies not to take such clients. Japan is just one example, there have been other regulators making complaints” stated Mr. Shmuely.
He continued by explaining that: “This is now changing. Cyprus is now making illegal under its own laws as well in order to demonstrate cohesion with other regulators around the world, which resulted in last week’s announcement.”
According to Joshua Sneider, Archer Consultants’ Vice President, “the Cypriot regulatory authorities are implementing new rulings such as this because they have lost a lot of power subsequent to the banking crisis, and are under pressure. Cyprus is a powerhouse in FX and this industry is largely responsible for keeping the island afloat.”
“Aside from Cyprus, we have a large client base of FX brokerages in Singapore, Hong Kong, and Indonesia which represent some of the markets in which Cyprus-based brokers are keen to operate, however most of the clients of Asia-Pacific brokerages do not trust Cyprus at all, they never did even pre-crisis, and they certainly don’t now. FX traders in those regions generally only respect Britain’s FCA, Australian regulator ASIC, and the New Zealand FMA, in that order.”
UK Expensive And Ambiguous, But Highly Respected
Another elephant in the room is beginning to make its presence felt in addition to these rulings, insofar as European banks are starting to apply strict risk management procedures to Cypriot FX and binary options firms, as a result of the banking crisis. According to one particular institutional broker in London, which has requested anonymity, “One of our Cyprus-based broker clients is trying to get a new bank account and is finding it slow going”.
He continued that “it is not the first time we have seen such occurrences, so it appears to fit a trend”.
Mr. Sneider has experienced similar situations in that “during the banking crisis, banks holding the operating capital of Cypriot FX brokers actually used their own risk management to freeze bank accounts, in order to ensure commitments could be met if the levy on funds kept in Cypriot banks caused a cash-flow issue. Subsequent to this, there are a number of banks which are reluctant to take on business from FX firms in Cyprus”.
On this basis, it could be considered a prudent move to avoid the extra costs of having two office, paying for two sets of regulations, one in Cyprus, one outside Europe, in order to attract a global client base, by applying for FCA regulations and operating from London.
Mr. Shmuely explained to Forex Magnates today that even this is not without its caveats: “The UK is subject to exactly the same Europe-wide law as Cyprus. Therefore, theoretically, the same issues could happen in UK. This means that it is not good practice to go and set up there to solicit non-EU clients.”
“The difference is that the FCA, and London’s financial center is long-established and very well trusted, and carries a lot of legitimacy. Additionally, it is home to many financial segments, not just FX as is the case in Cyprus. Non-EU countries are having a go at Cyprus because Cyprus is in a much weaker position than the UK, and have a lot of brokers based there, far more than are based in the UK.”
“On top of that, the authorities in other countries don’t trust them because of the bank failures. In theory, the authorities in non-EU countries could go to the FCA and complain that the FCA is allowing firms to solicit non-EU clients, but the FCA is strong and doesn’t react. Conversely, Cyprus is capitulating to these other authorities due to pressure. We don’t know exactly from how many government bodies they are receiving complaints, but the other jurisdictions are putting the pressure on” continued Mr. Shmuely.
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Fixed Or Variable Cost?
A major difficulty in establishing in the UK is that its cost structure is variable, and in some cases can be reasonable, whereas in others can be astronomical. Mr. Shmuely stated that “It is not the set up cost that is an issue for brokers in the UK, it’s the variable ongoing costs compared to known, fixed costs elsewhere.”
“As an example, to set up in Cyprus or Malta costs around 30,000 Euros. To gain regulations in the UK is around 30,000 Pounds, and ASIC will cost around 40,000 Australian Dollars, so it is all quite similar at the start”.
“The problem is the ongoing costs, which are brought about over ambiguity over how many key people are required, and how many hats can be put on the same employee. In all jurisdictions, a firm can nominate the same employee as CEO as well as Compliance Officer, but this has parameters and is limited. For example, setting up in Cyprus you need eight key employees, but you can get away with two or three nowadays. They used to enforce this rule but now it is easier plus you can outsource certain aspects”.
“The overall cost is about the same for running operations in Malta and Cyprus but Malta is unknown so therefore nobody knows how friendly the authorities there are to brokers, whereas Cyprus is friendly which is why it flourished.”
“This is where the UK totally differs and can cause brokers to incur extremely high and often unnecessary ongoing costs. The overall operating cost in the UK depends on the expertise of the person making your application. One application may be approved with a capital requirement of 730,000 Euros for market making, whereas another may require 1.5 million Euros” stated Mr. Shmuely.
Mr. Sneider detailed this further: “MiFID says that the minimum net capital requirement for FX firms is 125,000 Euros for A book, and 730,000 for B book. In Cyprus, a fixed amount is always applied; therefore every applicant knows exactly what to expect. CySEC asks for 200,000 Euros for A book, and 1 million Euros for B book business. Malta always asks for the minimum amount which is 125,000 for an A book business, and 730,000 for market makers. In France and Germany, applicants must be a bank.”
“When comparing other jurisdictions like Liechtenstein, the capital requirements are always set at the minimum level but they never issue licenses for FX companies. Iceland is the same and after their own crisis it is unlikely that a market there will flourish. However, despite this, all of these parameters are fixed, whereas the UK doesn’t state the actual costs.”
“A broker could potentially start up with 125,000 Euro, but the FCA doesn’t specify. It depends on the experience of the firm doing your application. It could end up being far more. This also applies to office, number of staff, responsibilities. All of these parameters are assessed on a case-by-case basis, meaning that annual operating costs under the FCA could prove to be in some cases no different to Cyprus, but in others, extremely expensive long term”.
“Human capital is another factor which adds to the costs in the UK. A broker cannot open an office in a cheap area like Liverpool or Sheffield where salaries are lower and real estate is cheap because they will not be able to hire the people with the experience required to satisfy the regulators, so all participants end up stuck with London prices” added Mr. Sneider.
“On the upside, taking a long-term view, the UK offers far more credibility and therefore a broker can derive a far better client base to grow the business. This however, depends on the compliance officer because in the UK each compliance officer is personally accountable for the onboarding of clients, unlike in Cyprus.”
Mr. Shmuely added that “If something goes wrong in the UK and the regulators get involved, brokers have to explain exactly what they said to a client, what actions they took, and justify everything. The FCA will in the event of an upheld complaint go after the compliance officer personally. The best outcome would be that he loses his own license and cannot do business anymore, the worst case is that he goes to jail.”
“Conversely, if a trader goes to a Cyprus company and open an account, and something goes wrong, CySEC will not go after the compliance officer and they will be very easy on the firm. Their interest is keeping the business in Cyprus.”
Malta The Next Cyprus?
As Malta’s regulatory authorities also fall under the MiFID laws, it is entirely feasible that Malta could become a further home to companies wishing to gain access to European client bases without having to go to the expense and rigor of obtaining an FCA license, or operating as a bank.
There are of course some developmental issues that need to be overcome, because Malta is only just making its foray into becoming a retail FX-friendly region, further demonstrated by its following CySEC’s path of regulating binary options as a financial product rather than a gaming product by transferring its oversight responsibility to the Maltese FSA from the Lotteries and Gaming Authority earlier this year.
Mr. Sneider stated that “Malta should be the new Cyprus. It will be interesting to see if Malta can pull it off, but at the moment it is nowhere near as well-oiled as Cyprus in terms of the procedure by which firms are regulated. At the moment, it takes 18 months to get regulations in Malta, and there is not much consistency with the process from one application to the next.”
“You cannot judge how any application is going to go. I can submit two identical applications, via the same attorney and get two different outcomes and different timescales” Mr. Shmuely added.
Accessibility is another matter, as most Cyprus based firms are owned and operated by companies and executive management teams which are based in other countries such as Russia, Britain, North America and Israel. There are no direct flights to Malta from a lot of countries which is a significant impedance.
Mr. Sneider said “If I want to go to Cyprus, I can get there for a day. I can fly in the morning and return in the evening. A lot of industry participants do this. Traveling to Malta from other countries such as the United States is a week-long effort”.
As yet, it is still early stages with regard to the potential effect of the new rulings, and after last week’s meetings between industry participants and CySEC, the date has been set back to October for full implementation.
Mr. Shmuely concluded by stating that he has not yet witnessed much demand from his clients to cease regulated status in Cyprus and move their operations to Britain, Hong Kong or Australia, but has noticed a number of existing firms wishing to lodge applications for regulation in other areas in addition to their existing CySEC regulated operations, plus new ones heading to New Zealand and Australia which are becoming areas of key interest for brokers wishing to continue to have unhindered access to Asia-Pacific markets plus a degree of credibility.
Times, as they say, are certainly changing.