Could Chinese IB business be brought to an abrupt end? Chinese government has busted $64 billion underground banking industry to clamp down on illegal capital outflows

A taboo subject among many senior executives in the FX industry is the method by which retail customers in China can deposit directly, or via IBs, into client funds accounts of brokerages outside China. China represents a vast proportion of retail FX order flow for western FX brokerages, and in some cases over 80% of […]

Could Chinese IB business be brought to an abrupt end

A taboo subject among many senior executives in the FX industry is the method by which retail customers in China can deposit directly, or via IBs, into client funds accounts of brokerages outside China.

China represents a vast proportion of retail FX order flow for western FX brokerages, and in some cases over 80% of business comes from the mainland, despite the communist government’s very strict capital control laws which forbid citizens to conduct business with foreign entities or to send their funds to firms abroad.

As last week drew to a close, the Chinese government uncovered the largest underground banking business in Chinese history, which involved transactions totalig $64 billion (410 billion yuan).

unnamed (1)
Andrew Saks-McLeod looks at China’s draconian capital control laws

FinanceFeeds has researched the Chinese methodologies very closely and has spent considerable amounts of time with China’s large IBs across the entire country, and as a result fully understands the necessity of having a good gateway that provides a facility to send customer funds to brokers overseas.

The Chinese government’s internet police department employs over 2.4 million government officials, and the authorities know exactly what transactions are being conducted and by whom, as the censorship and monitoring of transactions and internet use is very accurate and detailed indeed. In essence, the government knows that large, multi-million dollar IBs are sending funds abroad, and keeps tabs on it but does not act.

Similarly, if a client complains that they have been mistreated by a broker outside China, there is not a single thing that the Chinese authorities can do about it as, in keeping with communist ethos, they only have jurisdiction over domestic affairs and will happily explain that this is the fault of the customer for daring to send funds abroad.

The investigation into the underground banking organizations which were sending funds abroad began in September this year, and focused on the costal province of Zhejiang. It found that dozens of Hong Kong-registered companies forged more than 1.3 million fake transactions to transfer money offshore. Indeed, the Hong Kong-based companies were effectively shells with no physical office.

New Zealand used to be a popular destination for this practice, with many supposed FX companies having listed themselves on the Financial Services Provider register in order to transfer funds to New Zealand and give customers the impression that they had an office in a Western, free market country.

When the Financial Markets Authority was formed, it immediately set about de-listing several hundred of these firms, ruling that they were shells and that offices in New Zealand should have physical presence including a compliance department.

Here in Guangzhou, large IB companies occupy modern offices. Photography: Andrew Saks-McLeod

China started cracking down on underground banks in April and has so far uncovered more than 170 cases of money laundering and illegal fund transfers, involving more than 800 billion yuan ($125.34 billion). The cases come as capital outflows reach hundreds of billions of dollars, triggering alarm in some circles.

The question is, with FX IBs with over $50 million in assets under management and businesses worth in some cases more than $200 million, the authorities may well crack down on these too, the reason being that, unlike Western FX brokerages, all of the Chinese firms are IBs which means that if a particular company has $50 million, for example, in assets under management, it means that company has sent $50 million of Chinese customer funds to an overseas brokerage.

Should this be the subject of a crackdown by Chinese authorities, it would most certainly create a massive hole in the profits of many western companies who rely on China’s IB network for their client base.

Recently, FinanceFeeds discovered that certain banks and exchanges within China are looking at offering a partnership with IBs so that the government can own part of the trading cycle (we are certain that the free regulation of FX will never happen in China), and therefore cracking down on what the country considers to be illegal capital outflows would be a very effective method of getting all of the IBs to place their business with Chinese government owned banks or exchanges, and pave a way for Western technology and prime brokerage firms to partner with Chinese exchanges to gain order flow, thus dealing directly with the Chinese government rather than through free market-style partnerships that the government cannot control.

unnamed (1)
Many shell companies were found registered here in Hong Kong. Photography: Andrew Saks-McLeod

In the case of the unauthorized banks, it has been stated by the Xinhua News Agency that the main suspect used non-resident accounts to facilitate more than 14,000 counterparties for the transfer of billions of yuan offshore. Another Chinese news source, the People’s Daily, stated that 21 counterparties’ bank accounts illegally transferred more than 1 billion yuan overseas and the suspect used the inability of some onshore commercial banks to identify non-residential accounts to help his operation.

Clients were asked to transfer yuan to domestic accounts and the money was then transferred to non-residential accounts the suspect controlled. Those accounts were then used to buy foreign currency with forged trade transactions, and directly funnelled the cash to offshore banks in Hong Kong and elsewhere, a similar method to that used to transfer funds to FX firms.

It has always been well known to all FX firms that in theory, it is not lawful from the Chinese government’s point of view to conduct business with Chinese customers wishing to transfer their funds abroad, yet many have concentrated so heavily on it that the Chinese retail market has become the mainstay of their business. Without a contingency plan in place, a quick decision by the Chinese government could this which, although will not come as a surprise, would cause a considerable protraction in revenues and the need to refocus for many.

Featured photograph: The KK100 tower, Shenzhen, China.

Read this next

Retail FX

Weekly Roundup: John Oliver rips into MetaTrader, Binance to pay $10 billion

Welcome to this week’s roundup, where we delve into the latest developments in the Forex, Fintech, and cryptocurrency markets. Stay ahead of the curve with our comprehensive overview of the week’s most impactful events and trends across these dynamic sectors.

Retail FX

Lark Funding reopens to US traders, MyFundedFX picks cTrader

Canada-based prop trading firm Lark Funding announced it will once again welcome clients from the United States.

Institutional FX

Cboe FX volume falls to lowest level since summer

Cboe’s institutional spot FX platform, known as Cboe Spot, today announced its trading volume for the month ending February 2024, which took a step back after a strong rebound in December.

Retail FX

ThinkMarkets secures lucrative DFSA license in Dubai

Melbourne-based broker ThinkMarkets has secured a license from the Dubai Financial Services Authority (DFSA) after it has already incorporated its new subsidiary in the Dubai International Financial Center (DIFC).

Digital Assets

New Horizen Lays Out Its Vision Of A Modular, Proof Verification Layer For Web3 Networks

Horizen is forging a new path for the future of blockchain with its New Horizen initiative, which is building a modular Proof Verification layer that’s dedicated to verifying cryptographic proofs for any settlement layer, beginning with Ethereum. 

Digital Assets

Karma3 Labs Raises a $4.5M Seed Round Led By Galaxy and IDEO CoLab to Build OpenRank, a Decentralized Reputation Protocol

Using OpenRank, developers and web3 companies can build consumer apps where people can discover, use, fund, read, or buy something on-chain without worrying about getting spammed or scammed.

Digital Assets

Worldcoin down as Elon Musk sues OpenAI CEO Sam Altman

Worldcoin’s (WLD) token dropped following news of a lawsuit against related company OpenAI. The lawsuit was filed by Elon Musk and accused OpenAI and CEO Sam Altman of breach of contract.

Institutional FX

Exegy’s Liquidity Lamp adds intraday data to outperform S&P 500 by 31.8%

Exegy has incorporated intraday signals into its AI-powered iceberg order detection tool, Liquidity Lamp. By adding intraday data to a baseline mean reversion strategy, Exegy’s model outperformed the baseline by 10.5% and the S&P 500 (SPY) by 31.8%, respectively in the out-of-sample testing.

Industry News

Think Elon Musk backed your crypto exchange? ASIC’s latest reveal may shock you

In an absolutely shocking turn of events that nobody could have possibly seen coming, the Australian Securities and Investments Commission (ASIC) has bravely stepped forward to reveal that, yes, those videos of Elon Musk passionately endorsing a cryptocurrency exchange are as fake as a three-dollar bill.