“If you look at why traders are choosing to go to offshore brokerage entities, it’s happening because the client couldn't get what they wanted at home through the regulated entities,” David Barrett, the CEO of EBC Financial Group (UK), elaborated to Finance Magnates. “And a lot of that is due to leverage.”
Barrett himself oversees EBC’s offshore unit, which is authorized by the regulator in the Cayman Islands. While the Financial Conduct Authority-regulated entity only onboards professional clients, the Cayman Islands unit takes retail ones, offering them contracts for differences (CFDs) trading services. EBC’s Cayman entity is a subsidiary of the UK unit.
Offshore Brokers “Have More Flexibility”
“The FCA is probably the hardest regime to run a brokerage under on the planet,” Barrett continued. “It was always difficult, and it's now even harder. They have a lot of restrictions.”
“If you have an offshore brokerage,” the EBC UK CEO added, “you are able to offer more leverage and have more flexibility when onboarding clients than you would under the UK regulations for example.” He further highlighted that having an offshore unit and an entity in a strongly regulated jurisdiction has become a standard model for the CFDs brokerage business as they try to cater to different clients' requirements.
Indeed, most brokers, including the top and fairly large ones, operate with multiple licenses, some onshore and others offshore. Interestingly, some brokers even gave up onshore licenses to move their operations completely offshore.
However, Barret pointed out that “the offshore business will become more difficult to maintain, not only for the brokers but also for the clients.”
“I think that the problem is there has been, and still are, a lot of bad actors operating from offshore jurisdictions,” he said. “It's been clear throughout the last decade or so that many of these offshore entities have set up in jurisdictions with very light or no regulation at all, and they've abused their clients.”
“Retail Clients Are Most Vulnerable”
When it comes to regulations, the regulators globally are only concerned about the risks of retail traders. One way these regulators are mitigating such risks is by limiting the leverages offered. The UK and the European Union were the first to implement a leverage restriction in 2018, which was later picked up by their regulator in Australia to introduce similar restrictions in 2022. The regulator in New Zealand also proposed such restrictions; however, the implementation minimum has not yet been decided.
“Retail clients are most vulnerable,” Barret said, citing that “on average 75% of all retail clients in the EU lose money.” He added: “They lose money because they're exploited, they're under-educated, and the gamification of the market, in general, is exploiting them.”
Despite the leverage restrictions protecting retail traders, Barret highlighted that “a section of retail clients would like more leverage that the rules allow at the moment; they understand what it brings but can not access it under the rules imposed now.”
“The problem is that there's a slice of clients that are classified as retail but aren't uninformed or incapable of understanding what they're doing,” he added. “But they can't be classified as a professional client under the rules that are in place at the moment. That slice of the client base is almost being disenfranchised by the rules that they have to comply with now there's no grey area, only a black-and-white line—either you are professional, or you are not. Many of these are being driven to look at offshore entities to trade with.”
“The Only Real Growth Is Still Coming from Asia Pacific”
Nowadays, CFD brokers are primarily expanding their operations into emerging markets. However, the term “emerging markets” seems to cover a wide range of jurisdictions, including Southeast Asia, Africa, and Latam. According to Barrett, “the only real growth is still coming from Asia Pacific.”
“There has been an effort in Africa, a lot of money's been spent, the original first movers have probably made some money,” he added, “but I think that there's been a lot of problems for clients, again due to the amount of bad actors out there. I suspect that growth is still there, but it's slower than it was at the beginning.”
“Latam is interesting but also difficult,” he continued. “The local regulations are a little more opaque than those of other jurisdictions. Many of them have currency controls regarding what you can and can't move out, the tax implications and how frequently.”
Commenting on the mature markets, he said: “If you want to set up a retail business in Europe, or the UK, there's little point if you are starting from scratch and on a small scale. It's a disaster; it's saturated, and it's very heavily regulated.”
“I think going forward, you'll see quite a lot of consolidation regionally and globally. You'll see a rush to well regulated jurisdictions,” he continued, adding, “I don't think there will be a major evolution in products, the scope of markets that are covered by brokers now is pretty much everything that you can trade, the real change going forward won't be products; it'll be jurisdiction regulation.”
Prop Trading “Model Is Ripe for Exploitation”
However, one fast-growing trading services niche which is still outside regulatory purview is prop trading. Barret believes much of the growth in this sector is down to “gamification.” He adds that “it's being offered people who are vulnerable to the marketing pitch.” He even adds that “for many the prop trading business model is praying on retail traders' egos.”
“If you're a retail trader, prop trading service providers will tell you that you can become a proprietary trader and you can manage a ‘pool of our money’. All of a sudden, you're a fund manager. That's a very strong marketing hook,” he explained.
“However, the client needs to pay a subscription fee to pass the initial ‘test’ for their capital allocation, sometime this is renewable each month. They'll get offered to upgrade the package in terms of the size of the cash pool available. It's all about managing people's ego; it's all about gamification. The real business model isn't about how well they or the client performs with their trading; it's about how much in fees they pay the broker to keep in the game of ‘I'm a prop trader.’ This model is ripe for exploitation,” he said.
Prop trading has attracted massive interest over recent years. Its popularity even forced some top CFD brokerage brands to enter this growing sector. However, the sector remains unregulated as prop trading services cannot be categorised as financial services.
Interestingly, the well-regulated brokers entering this new space offer prop trading from their offshore entities.
Barret also questioned the market structure of the prop trading model, calling it “dangerous,” which, according to him, is incentivising brokers to keep such services offshore.
“As the client isn't putting any collateral down and the broker is effectively funding the capital for him, the broker chooses what risk is run and how it is managed—not the client” he said. “None of this activity is regulated and has the potential to cause problems for the client when they reach a point where they expect a return from the broker.”
“All of these platforms are offshore at the moment,” he continued. “My own opinion is that as soon as the brokers try to move onshore, to Europe, the UK, the US or some of the more reputable jurisdictions, they're going to experience a wall of regulatory pain. These platforms are designed to state that they are not offering you investment products, that nothing they are doing is in the scope of regulation; onshore this is not going to be tolerated.”
“It's going to have to stay offshore, problems will persist and increase and eventually, people will realise they're being exploited,” he added. “In many ways it’s another iteration of the binary options market.”
