It’s been a year of heavy lifting for the retail foreign exchange and CFDs trading industry. The introduction of additional regulations and the reshuffling of regulatory measures and compliance requirements has put a dent on activity across the globe.
The latest news about changes to the major regulatory jurisdictions for the Forex and CFDs trading industry have come out of Australia earlier this week. The Australian Securities and Investments Commission (ASIC) published a new consultation paper on Wednesday, aimed at enacting new client money laws for Australian Financial Services licensees.
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ASIC’s paper stated that the changes are to be enacted in April 2018, which gives Australian brokers more or less 10 months before major changes come to the market. The regulatory landscape is likely to result in a drastic change for the industry in Australia, as only brokers with larger balance sheets will be able to continue operating.
The capital requirements which brokers are subjected to at present in Australia mandate $1 million plus 10 percent of the company’s revenues. Smaller companies simply wouldn't be able to cope with the new requirements for client money, especially if they want to provide straight-through processing (STP) of orders to their clients, without having the right to use their deposits as collateral with prime brokers.
The Director of Australian compliance and legal consultancy firm Sophie Grace and Director of TRAction Fintech, Sophie Gerber, said: “Before April 2018 brokers will need to do a number of things, including determining which clients are retail clients and which clients are wholesale. Firms will need to clearly differentiate these categories including ensuring you they appropriate wholesale/sophisticated investor documentation on file to meet the Corporations Act requirements.”
“Brokers may also need to get funds back from any hedge counterparties or other investments where it is client funds to ensure balance from at least a few days before matching client monies,” the compliance expert elaborated.
Consolidation Incoming?
The news about new client money laws didn't come as a surprise, but nevertheless the impact on the industry could be significant. Speaking to Finance Magnates, the Managing Director of OANDA Australia, Anthony Griffin, said: “We believe the FX and CFD landscape will change significantly as a result of the Australian Federal government’s decision to move forward with the law on the segregation of client funds.”
“Because they will no longer be able to use client funds for their own purposes, there is a chance some of the smaller broker dealers operating in the margin FX and CFDs space will struggle to meet the minimum capital requirements laid out by ASIC. We could also start to see consolidation within the industry, with many larger firms acquiring these smaller operations as they become available,” Mr Griffin elaborated.
STP brokers will have a particularly hard time in meeting the requirement of not putting up client money collateral with their prime counterparts.
ILQ Australia’s Director, James O’Neill, explained: “Many brokers will have concerns in regard to ASIC’s proposal to ‘close’ the written direction exemption. This will have a significant impact on STP brokers. In my view, this will result in significant changes to Prime Broker and prime of prime broker arrangements and may also result in consolidation within the FX market in Australia.”
“The increased capital to operate coupled with rising operational costs may force less-capitalized STP brokers to take greater risks to stay profitable. This would likely mean internalizing more risk on the brokers’ book due to margin constraints at their hedging counter-party, or simply passing on these increased costs onto the client. A natural flow-on effect would be consolidation within the industry and a heightened barrier to entry,” noted Simon Stephen, Managing Partner of Charterprime.
A Step in the Right Direction Nonetheless?
While compliance and capital requirements for brokers are going to become more burdensome for many, the industry is responding in a positive way to the changes. A spokesperson for the CFD Trading & Compliance Forum in London, a broker-led members’ forum that addresses key matters impacting the CFDs industry, commented: “Client money protection and assurance policies are a step in the right direction and will definitely give the trading community the much needed confidence and comfort that during difficult times there are adequate systems and controls in place to safeguard their funds & assets.”
Charterprime’s Managing Partner Simon Stephen shared: “I believe ASIC has taken a step in the right direction in exercising their power to make new client money rules. Undoubtedly, this will simultaneously reduce counterparty risk and provide more transparency with increased reporting standards. It's our view that these changes, whilst designed to protect client money will have profound changes on the OTC derivatives space in Australia."
“In principle, ASIC’s consultation paper relating to client money, is positive for the industry. The carve-out for non-OTC derivatives is both expected and appropriate,” ILQ Australia’s Director O’Neill adds.
OANDA Australia’s Anthony Griffin elaborated on the magnitude of the changes: “For years now, Australia has stood out as the only market in the world that allows brokers to hedge client positions with the customer’s own money.”
“This new law will bring us into line with other international markets that ensure client funds are protected and secure, not only safeguarding investors but also ensuring the Australian FX and CFD markets are underpinned by a strong regulatory framework,” Griffin elaborated.
Prospects and Considerations
Coming back to the long term implications, there are many unknowns when it comes to the real impact of the changes to the Australian market. According to Sophie Gerber, while some brokers may fold or sell their assets, ASIC could in theory start issuing more licenses due to the new, stricter rules.
Another point Mrs Gerber elaborated on is on whether we will see local brokers move towards a 'sophisticated' investor model: “Given clients that meet the wholesale investor test are carved out from the client money rules, meaning that their funds can still be used by the broker to hedge their positions.”
Regardless of the changes to the Australian market, brokers that are operating with a solid business model still have a future. While in the short term their capital requirements may go up, interest from clients in opening a trading account may increase due to the additional protection provided by the law.
Until we see the endgame, brokers have close to 10 months to reassess their options and submit their comments to ASIC and take measures to address the upcoming regulatory changes.
