Analysis: Who Cares About Client Losses Anyway?

Regulators' myopic focus on loss numbers isn't doing much to improve the retail trading industry

Speaking at a regulatory conference in Sydney on Tuesday, Cathie Armour, a commissioner at the Australian Securities and Investments Commission (ASIC), once again touched upon the number of clients that lose when trading with over-the-counter derivative products.

It wasn’t the first time that ASIC has expressed concern about client losses. In her speech, Armour was actually referencing a study carried out by the regulator last year to uncover what percentage of clients were losing when trading in binary options, foreign exchange, and contracts-for-difference.

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A regulator discussing client losses is likely to send executives at many brokers into a cold sweat. It was this particular issue that the European Securities and Markets Authority was able to stand upon and use as the main support for the restrictive product intervention measures it introduced just under a year ago.

ASIC’s turn

At the iFX Expo in Cyprus last month, a number of executives – both publicly and privately – expressed the view that ASIC is likely to enact similar measures over the next couple of years. And again it seems that client losses will be the excuse they need to put those rules in place.

The bewildering thing about this regulatory obsession is that client losses have always existed. Even prior to internet trading, clients that placed their orders over the phone would still lose about 80 percent of the time.

Given that’s the case, it’s slightly irritating that regulators are only now starting to say that the 80:20 ratio is problematic. But we all know why they are doing it.

Ultimately, financial authorities have three major problems with the retail trading industry- dodgy, get-rick-quick marketing practices and welcome bonuses, massive leverage that allows a broker to wipe out their clients almost instantly and scams.

No nuance

A quick look through the FCA warning list would illustrate that the last of these problems has not been solved by regulation. ESMA’s rules in Europe have, however, killed bad marketing practices and over the top leverage.

Regardless of the efficacy of those rules, ESMA still ties its protective measures to client losses. And now there’s a good chance ASIC will do the same.

All of this is misleading. First off, client losses have, as noted, always hovered around the 80 percent mark.

The other problem is that it doesn’t give a true picture of what a losing client looks like. For instance, in a three month period, you might make money. In the following three months, you might lose money.

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Undoubtedly there are cases such as this. And that means there is a level of interchange between the 80 percent of losers and 20 percent of winners. The two groups are not set in stone as a simple percentage implies they are.

Lost $10? Lost $1,000,000? You’re all the same

Aside from this, the 80:20 ratio lacks nuance because it means everyone who lost money, regardless of how much they lost, is bracketed together. But clearly, someone that lost $50 is not in the same sphere as someone that lost $5,000.

Ayondo, an FCA-regulated broker, was the first to – implicitly – point this out. In September of last year, the firm attached another line to its ESMA-mandated risk warning, a warning that forces brokers to say what percentage of their clients lost money, saying that over 70 percent of their losing clients lost less than £100.

That add-on, which has now disappeared from the broker’s site, seems appropriate. It provides some more granular detail to an otherwise broad brush statistic.

Making client losses such a sticking point in the road to improving the retail trading industry is also unhelpful as it doesn’t necessarily say anything about the quality of service a broker provides.

For instance, there are some companies that, though it is hard to believe, appear to genuinely not trade against their clients. That doesn’t necessarily mean they are better than their competitors, but it does remove a major conflict of interest between a broker and its customers.

Still, traders using those brokers’ services continue to lose money about 80 percent of the time. The same is true of major firms which, by and large, offer an extremely high level of service to their clients.

Better service, same losses

Whether they intended to or not, regulators, with a focus on losing trader numbers, are actually blurring the line between good and bad firms. When you imply that client losses are inversely proportional to providing a good service, it means you are suggesting low losses makes for a better company.

But that just isn’t true. As one liquidity provider pointed out at iFX Expo, most traders are just not going to beat the spread.

And even if you provide an amazing service, you might have terrible traders who, being terrible, are much more likely to lose money.

Regulators are right to be concerned with some of the conduct in the retail trading world and, if clients are losing money because they are being misled, that’s a problem.

Overwhelmingly, however, that doesn’t seem to be the case. Instead of focusing on losing customers, regulators would better serve the industry by formulating rules which are conducive to firms improving their services.

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