Cappitech’s Ron Finberg takes a look at European regulatory view on execution and slippage

Ron Finberg, Business Development Executive at Cappitech, takes a look at the European regulatory authority ESMA’s questions and answers with regard to execution, slippage and how dealing desks should operate. As binary options and other high risk leveraged products for retail customers have been garnering negative headlines recently, the European Securities and Markets Authority (ESMA) […]

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Ron Finberg, Business Development Executive at Cappitech, takes a look at the European regulatory authority ESMA’s questions and answers with regard to execution, slippage and how dealing desks should operate.

As binary options and other high risk leveraged products for retail customers have been garnering negative headlines recently, the European Securities and Markets Authority (ESMA) has published a Q&A paper on CFDs and other speculative products such as binary options and forex. Similar to other Q&A’s released by ESMA, the report is aimed at provided explanations in regards to how rules and products should be interpreted and is updated periodically.

In the inaugural Q&A paper devoted to CFDs, an entire section was devoted to conflicts of interest. Specifically, with MiFID creating a framework in the EU that firms are supposed to take reasonable steps and preventing conflicts of interest with their clients, how does that work when a broker profits from a customer’s loss? Below are some of the key items covered

Asymmetric slippage: Execution slippage takes place when prices have changed between the time an order has been sent and it is executed. Depending on the moves of the market, traders can experience both negative and positive slippage on their orders.

In the case of asymmetric slippage, this is the practice of brokers applying negative slippage of prices to customers when it is to their detriment, but not providing them positive price improvement when quotes have changed in their favor. One of the most famous cases of brokers being penalized for this was a $16.9 million fine applied by the UK’s FCA on FXCM in 2014.

Covering this topic, ESMA stated that using a model of asymmetric execution slippage that negatively affects customers would show that the broker isn’t “taking all reasonable steps to avoid conflicts of interest”.

Dealing desk model: In regards to brokers that use a pure market making dealing desk model that profits on client losses without hedging, ESMA stated that this mode should be avoided as they stated:

For example, a firm offering CFDs or other speculative products acting as the counterparty to a retail client’s trade without any hedging arrangements in place has no incentive to execute orders in the best interest of the client, because if the client “wins”, the firm “loses.” Such a conflict of interest in all likelihood cannot be managed and should therefore be avoided, by not adopting such a business model.

Compensation: Another topic covered was compensation as it related to conflict of interest. Not surprisingly, this issue is a sensitive one in the forex and CFD industry as sales and support staff often have bonuses tied to new customer deposits and ongoing retention.

ESMA answered that brokers need to put in place suitability processes to ensure that customers that aren’t a fit for the risk of CFDs, binary options and forex trading aren’t sold to.

In addition, brokers need to analyze whether their remuneration practices poise a conflict of interest with their customers. While ESMA didn’t address this specific case, based on their wording, likely falling in the category of poor practice is the practice of retention staff to be penalized for customer withdrawals of profits.

This is a guest editorial which represents the view point of, and was compiled by Ron Finberg, BD at Cappitech.

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