“It was the best of times… It was the worst of time…” or so wrote Charles Dickens many years ago, but today’s forex brokers are mumbling similar words and much worse under their breath, after being double-body-slammed by the likes of the FCA and CySEC early into his holiday season. Without warning, there appeared to be a coordinated effort on the part of these two regulators to deal with their rising consumer complaint logs with a flurry of new rules and regulations, issued coincidentally before 2016 had come to a close. Their last minute antics have sent stock values plunging and brought more uncertainty to an industry that has grown accustomed to adapting to change.
What are these new rules and regulations? These agencies did not issue a single statement together or promote a similar agenda of corrective guidelines, but the general themes were the same – protect the consumer by restricting current business practices. The basic thrust was to limit leverage, prohibit bonuses, and publish greater disclosures regarding the actual profit or loss experience of retail trading clients. In many respects, these new rules follow what the CFTC brought to bear on the U.S. market some years back. The response then was that a host of forex brokers exited that market, never to return again. Will clients jettison regulated brokers for more flexible offshore offerings? Actions like these may minimize risk in one quarter, but then increase it in another.
What, when and why did this regulatory attack come down?
One could almost feel and see the storm clouds gathering over the forex industry for the past year or so. Regulators had faced public condemnation in 2015 for not acting proactively and forcefully enough to stem not only fraud in the industry, but also a rash of bad business practices that bordered on outright fraud in their own right. 2016 began with regulators in every jurisdiction revealing that an avalanche of consumer complaints was engulfing their offices on a worldwide basis. If it were not delays in processing withdrawal requests, then it was a preponderance of aggressive salesmen pounding away on unsuspecting consumers.
Soon thereafter, a series of articles by Simona Weinglass, an investigative reporter for the “Times of Israel”, exposed the unscrupulous underbelly of the binary options industry. Her articles revealed that, “Fraudulent binary options is a vast criminal enterprise, employing thousands of people in over 100 companies, many of them in Israel, but also in countries like Romania, Bulgaria, Ukraine and the Philippines. The industry is thought to earn hundreds of millions, if not billions of pounds a year and victims worldwide are believed to number in the millions.”
When regulators followed up on the misgivings in France, Belgium, the UK, and other countries in Europe, the number of victims and the amount of losses were staggering. Since the crooks had been clever enough to avoid targeting Israeli citizens, the Israeli Security Authority (ISA) had been slow to react to the problem, but after pressure from a number of countries and the threat of monstrous lawsuits, the Israeli regulator finally took steps to police the domestic offenders in its midst.
A number of other agencies did not wait for cooperation from ISA. The complaints were not only about nefarious tactics in the digital option space, but also about spread betting and Contracts for Difference (CFD) deceitfulness. The officials at ASIC in Australia had been complaining about CFDs for some time. France banned the marketing of binary options. The Netherlands and Germany were considering similar measures, while little Belgium executed a prohibition on CFDs and binary options altogether. Japanese and U.S. authorities have never recognized a CFD as a legitimate investment security, and neither permits trading in binary options unless it is through a regulated exchange.
Independent groups at CySEC and the FCA, however, had been investigating the misgivings of both products for the past year. CySEC actually has regulatory oversight over both products, but the FCA can only speak to CFDs and spot forex trading. In the UK, binary options fall within the purview of the Gambling Commission, but it too may soon be transferred and become a responsibility of the FCA. Although binary options have been the fastest growing sector of the forex industry, it has done so with very little in the way of regulatory guidance, as if it were expected to self-regulate.
CySEC was the first to act last week, issuing “a circular to the Cyprus investment firms setting some new rules regarding trading bonuses, maximum default leverage and fund withdrawal processing terms. In essence the new rules concern all forex and binary options brokers regulated by the CySEC.” The FCA followed this week with proposed regulations and announcing that it “welcomes feedback on the policy measures we have proposed by 7 March 2017. Subject to these responses, the FCA will seek to publish a final policy statement and final Handbook rules by late spring 2017.”
CySEC was first out of the starting blocks
CySEC officials did not waste anytime with a review period. Their published circular gives forex and binary option brokers until January 30, 2017 “to take the appropriate measures and actions in order to operate with the new rules”, related to bonuses leverage, and fund withdrawals.
With regard to bonuses, CySEC was very clear. Brokers “must avoid the practice of offering bonuses that are designed to incentivise retail clients to trade in complex speculative products such as CFDs, binary options and rolling spot forex as it is unlikely that a firm offering such bonuses could demonstrate that it is acting honestly, fairly and professionally and in the best interests of its retail clients”.
The use of excessive leverage also came under fire. Leverage in forex trading can magnify gains, but also losses. Brokers, as a rule, encourage leverage, since it also magnifies their fee income on each transaction, a fact not often shared with the consumer. CySEC officials, however, erred on the side of leniency in this area. They proscribed a “50:1” level as the default, but clients could be allowed to choose a higher level, if they wished. There was also an additional caveat that leverage must be limited to those clients “who have failed the appropriateness test.”
Lastly, CySEC also stipulated that brokers must ensure that a clients may not lose more than they have in their account balance, i.e., negative balance protection, and, if the account balance is in a positive position, then a withdrawal request must be processed on the day it is received or the next day, if it is received after daily deadlines.
What did the FCA have to say?
The FCA followed a more deliberative route by putting proposals out for comment, before being enacted. Although the agency does not yet have oversight authority for binary options, it still let the industry know that it should be on guard: “The FCA also has concerns that binary bets pose investor protection risks and question whether binary bets meet a genuine investment need.” In other words, more will come later, after the transfer of responsibility from the Gambling Commission.
The FCA’s primary focus was on the CFD trading industry, and rightly so, since their analysis showed that, “82% of clients lost money on these products.” Per Christopher Woolard, the Executive Director of Strategy and Competition for the FCA: “We have serious concerns that an increasing number of retail clients are trading in CFD products without an adequate understanding of the risks involved, and as a result can incur rapid, large and unexpected losses. We are introducing stricter rules for CFD products to ensure the sector addresses the shortcomings identified, and that firms make sure that retail clients are aware of the high risks involved in trading these complex products.“
Justin Bates, an executive with the Liberum investment bank, expects a positive outcome and a quick dispatch of the unscrupulous types in the industry. For the time being, he summarizes the FCA proposals, as follows:
- Introduction of standard risk warnings and mandatory disclosures of profit-loss ratios on client accounts;
- Preventing providers from using bonus benefits to encourage account opening or trading activity;
- Capping leverage at a max of 1:25 for retail clients who have less than 12 months experience;
- Capping leverage at a max of 1:50 for all retail clients.
What was the reaction of the market to this new news?
The market reaction was swift and severe. Several major CFD providers are traded on the London Stock Exchange. When the news spread that revenue projections could easily be impaired in 2017 and forward, a fire sale was on. Shares for once popular gambling entities plummeted by 30% or more. The most notable victims were the IG Group Holdings, CMC Markets, and Plus500. Each firm reacted with hastily prepared press releases to, hopefully, stem the carnage. Here is a sample of their comments:
IG Group Holdings: “IG firmly believes in robust and proportionate regulatory oversight of the CFD sector in the UK and Europe. The Company recognises that there are shortcomings in the approach to the marketing of CFDs and binaries by certain firms, often operating from outside the UK.”
CMC Markets: CMC was quite brief, only noting that it has “consistently focused on higher-value experienced premium clients who understand the markets and products they are trading… its business model and ongoing strategy… focused on generating revenue from client trading costs and therefore believes in establishing long-term client relationships.”
Plus500: Per comments in other press articles, “Plus500 did admit that the new rules will indeed have ‘a material operational and financial impact‘ on its UK business. However the company indicated that its FCA regulated entity only accounts for about 20% of the company’s overall revenues.”
Coincidentally, the shares of Playtech, headed by Israeli billionaire Teddy Sagi, only lost 6% in early trading, a bit of an anomaly when compared to its competitors. Playtech is not as entrenched in the CFD space and recently unloaded its presence in the binary options arena. One pundit also noted that, “Playtech shares did drop about 10% last week, after controlling shareholder Teddy Sagi announced he was selling £329 million Playtech shares, more than one-third of his stake in the company, at a significant discount to market.”
The costs of doing business in a few of the more lucrative areas of the forex industry just got suddenly higher. Regulators rarely care about the impacts their actions might have on investors. They like to think that their actions are in the public good, but only time will tell if these overt attacks actually deliver the intended benefits.
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