Cyprus brokers still zeroing accounts by using dodgy offshore entities

We investigate a case in which a novice trader lost over £50,000 to a Cyprus broker which onboarded him via a St Vincent and the Grenadines entity then provided 1000:1 leverage and a bonus – both illegal in Cyprus under ESMA, but CySec does not seem to care about this prevalent practice of using CySec regulation as marketing bait then providing unregulated, casino-like bucket shop accounts

One of the moot points that has divided opinions between brokers, traders and regulators over recent years has been the leverage percentages which OTC derivatives brokerages and electronic trading companies are allowed to offer to retail clients.

Opinions vary on whether the leverage restrictions on spot FX and CFDs which have been a priority of regulators in the UK, Australia and across Europe over recent years are good or bad for business, some of the more reputable companies understanding that this is a stabilization method which should be adhered to, and that traders should place more margin capital in their accounts and be subjected to less risk, and others choosing to find ways around it.

The European Securities and Markets Authority (ESMA) was one of the first regulators to implement a leverage restriction in markets outside North America and Japan, and in doing so in 2018, was met with mixed perspectives and actions from brokers.

Japanese regulatory authorities had restricted leverage to 1:25 some eight years ago. Japan, being the largest retail FX market in the world and home to over 35% of global retail FX volumes, all traded by domestic market clients through domestic market companies, was a great model for the implementation of strict leverage restrictions, as volumes actually rose even further following the 1:25 leverage ruling.

Things outside Japan were somewhat different however.

In Cyprus, home to over 150 retail FX brokerages, ESMA’s ruling was not as welcome in many cases, as firms began to onboard their clients via offshore entities under the same company in regions such as the British Virgin Islands or St Vincent and the Grenadines, those being regions with no regulation at all, and no resrictions on leverage, and then continue to hold a CySec license in Cyprus and use it as a marketing and client onboarding tool whilst not putting any clients through it.

FinanceFeeds investigated this in detail some years ago, as many firms were conducting this practice well before the leverage restrictions were enforced, making it even easier to subvert the rules once they were enforced.

As CySec has no jurisdiction outside Cyprus, and firms are allowed to operate sister companies with offshore licenses and onboard clients to those entities with all kinds of terms that would not be permissible under ESMA, CySec is powerless to prevent any firm from offering extremely high leverage, bonuses and other non-compliant trading terms via offshore entities and then tell clients that they’re ESMA regulated.

Neither ESMA nor CySec stipulate that if a broker holds a CySec license, it cannot hold any other offshore offices, nor does it stipulate that brokers must only onboard clients to a CySec entity.

This loophole has come to light once again today, as FinanceFeeds has spoken to a novice trader who claims that he has lost £50,000 with a publicly listed social trading broker with a CySec license, and a St Vincent and the Grenadines offshore entity as a result of the flouting of leverage rules.

The company in question completed an IPO some years ago, listing its stock on a European exchange, and considers itself a robust company. It has offices in Cyprus and an ‘office’ in St Vincent and the Grenadines.

This morning’s conversation between FinanceFeeds and said retail trader showed that the offering of high leverage is alive and well among Cyprus brokers which are using the loophole to get around regulations, and doing so perfectly legally.

“As someone with no trading experience i opened trading account with a social trading broker which holds Cyprus license hoping to make some extra funds on the side on auto copy. I have been trading with them for about 3 months and ended up losing £50k because I was setup on an account with leverage of 1000, only after reading articles on FinanceFeeds I have realised being UK national I shouldn’t have been leverage that high and I was registered in St Vincent and the Grenadines without being made aware or my approval” said the client.

“Within the first week I lost £20,000 that I had deposited as I had no idea that a £1000 trade had completely different value compared to £1000 trade opened by another trader I was trying to copy trades from due to different leverage.”

“I decided to contact my account manger and told him i dont think this is for me and i am going to stop. This would have been end of it but i was convinced that this was bad luck and i should give it another go and to help recover the losses company will offer me 100% equity bonus and greed got better of me and i ended up depositing more funds” said the trader.

“During the following month, markets went up and I made a lot of profit and as soon as I did, I lost it all as soon as the market crashed but still managed to save about £10,000 equity and funded £10,000 more and decided to leave the account on auto copy couple of good traders I had found by that time, but my account manger told me he was going to give me trades and from now on and I was only going to open these trades” said the trader.

“This account manager asked me to sell 4.5 lots of silver and 2.5 lots of gold on account balance of £20,000 plus £15,000 equity bonus that was added to my account so total equity of £35,000. Subsequently, trades went in the opposite direction and my account manager stopped me from taking any action assuring its just because of some news and it will go back so I should close the computer and leave the trades to run and as expected I blew my account and trades closed with £20,000 loss and equity bonus that was added to my account was not used and explanation for that was company is not going to risk its own money.  Nowhere in there terms and conditions its mentioned equity bonus is not useable or any situation where it can or cant be used” he said.

“As things stand, my view is that this particular CySec regulated broke ESMA regulation regarding leverage and bonus plus violation of trading license by opening trades for a client and then closing my trades in £20k loss even though there was still £15,000 equity left in account and margin level well over 50%” he said.
“I have filed a complaint and thus far being offered £15,000 account credit which i have refused. I currently do not know know how strong my case is if I were to take it up with CySec because I can;t find anything online if or how CySec deals with these kind of violations nor does it point out what kind of further action I can take” concluded the trader.
Unfortunately, if this can be taken at face value, this particular broker has pulled a fast one and done so perfectly legally due to CySec’s loophole that allows firms to onboard clients of CySec regulated brokers via offshore entities.
In 2018, shortly after ESMA’s tightening of rules, FinanceFeeds looked closely at this dubious practice, and the slack approach by CySec at dealing with it.
At that time, FinanceFeeds investigated a reasonably prevalent situation in which some small to medium sized retail FX brokerages with CySec regulatory licenses which bind them to operating under the European Securities and Markets Authority (ESMA) rulings and MiFID II market infrastructure directives have been onboarding clients to offshore entities in order to circumvent rulings on trading terms.

Aspects like leverage restrictions and ‘best execution’ procedure were parameters that certain firms sought to avoid, and in some cases continue to do so, by maintaining an office in Cyprus with a CySec license that has just a few clients on its books, whilst bringing on board the vast majority of clients from non-European jurisdictions (most Cyprus based brokers do not have any clients in Europe) via an offshore entity and offer over 1000:1 leverage with B-book execution.

In a detailed report by FinanceFeeds, we looked into the corporate and regulatory stance on this practice, the latter of which was one of complete apathy.

Subsequent to that investigation, a further point of interest with regard to this dynamic has surfaced.

Following a conversation with three experienced retail traders in Canada, FinanceFeeds can vouch that whilst the offshore entities using their sister company in Cyprus as marketing ‘bait’ and claiming to be regulated under European rulings whilst actually offering clients completely unregulated offshore accounts, some companies approaching clients in bona fide, well regulated jurisdictions outside Europe – such as Canada – are doing so from within Cyprus and offering terms that, whilst legal under a CySec license, are against Canadian regulations.

Under a circumstance such as this, the Canadian provincial regulatory authorities – Canada’s non-bank financial markets firms are regulated by separate bodies for each province – could contact CySec and ask them to issue any company that does this with a cessation order, as both Cyprus and Canada are regulated under continental structures that have cross-border collaboration.

Put simply, brokers can quite easily abuse their CySec license by using it as a marketing tool to sell retail trading accounts to non-European customers and then flout all of the rulings by putting all of that business through an unregulated sister company in the Marshall Islands or Seychelles and go completely against the customer protection that the regulators in Europe have designed the MiFID and EMIR rulings to uphold whilst the customer thinks he is safe, whilst bona fide brokerages in Cyprus who uphold the rules and seek good business from traders in non-European first world countries could land themselves in trouble!

This highlights a fundamental flaw in the regulatory structure which has long been a by product of a global, online financial markets industry, that being standardization, or indeed the lack of it.

Scenario A: Rip off customers by giving them an account with over 1000:1 leverage by bringing them in via an offshore entity despite their belief that they are trading with a regulated firm and get away with it.

Scenario B: Offer good quality, completely compliant trading terms to a non-European client in a high quality, financially safe region such as Canada and get in serious trouble.

It may not make rational sense, but that is one of the challenges faced by regulators and quality brokerages at the moment.

One particular Canadian trader today stated “I live in Canada and according to this site which operates in Canada for the Canadian division of Interactive Brokers, the maximum leverage is around 30 and they have to stick to that that from the Canadian IIROC regulations.”

He continued “What I want to know, however, is if use a site like from one of the larger Cyprus based brokers which allows me sign up under a Canadian residence, but under their Licenses & Regulations there is nothing about IIROC, however, under their risk warning tab they write this: “It is the responsibility of the Client to ascertain whether he/she is permitted to use the services of the brand based on the legal requirements in his/her country of residence.” So if i live in Canada and i try and use more leverage, what would happen? Or, what would happen if i used the same amount of leverage that is listed under the IIROC but on this site?”

A very good question indeed. The disclaimer mentioned, this particular one is on a well known retail firm’s website, the company also having a Belize entity, thus showing that this firm is another that engages in offshore onboarding of clients outside CySec’s remit, demonstrates that being regulated in Europe means that only European rules apply if the broker and the client are in Europe, and rather than offer blanket leverage according to the CySec license provided, it appears that the firm allows trading at any leverage, transferring the responsibility to the trader should things go awry.

One answer to this came from an experienced retail trader who stated “If you want your money to be safe, trade with an IIROC regulated broker like Interactive Brokers or Oanda, because you are in Canada and if the regulatory body, the broker and you are all in the same region, you will be better protected and the terms will be relevant.”

“Slightly shadier would be foreign brokers but regulated in first world countries, however you would still very likely be quite ok with that, but some of the small CySec brokers do not have an office in Canada and most of the time their owners do not live in Cyprus either, and therefore the funds are sent to bank accounts in a completely unregulated area. If the broker doesn’t have a physical office in your country and/or isn’t regulated in your country, you’re most likely going to find no recourse if something goes wrong, so just stick with IIROC regulated brokers if you want peace of mind. That way you can report your broker to them if you feel you’re being cheated.”

Whilst that is sound advice, it is a great shame that proper brokerages which would adhere to rules would likely fall foul of international regulatory lobbying, whereas those who completely avoid bringing any customers on board from well regulated first world regions and then do so via a ‘back door’ office on an island in the Caribbean with absolutely no trace of such accounts anywhere near a European regulatory trade reporting system would likely continue to get away with this practice.

Over the past year, we have seen the implementation of MiFID II which has completely changed the way execution practice and trade reporting along with client treatment are handled, at great expense to brokerages worldwide and with compliance officers having to literally place their careers on the line and be responsible for an entire set of very complex rulings, yet the offshore databases held by CySec brokers continue to grow, completely out of sight of the European regulators, despite European regulation being promised to customers.

FinanceFeeds has spoken to CySec on more than one occasion regarding the allowing of licensed firms to onboard clients and provide them with non-compliant offshore accounts. Today, FinanceFeeds spoke to CySec on the issue regarding leverage and potential consequences, and how this is overlooked and could cause trouble for brokers who are trying to get it right.

On all occasions, the regulatory officials replied with a metaphorical blank expression, admitting that they had no idea what either of these scenarios relate to. Indeed, I have personally spoken to CySec officials about this in clear detail, and they appear to give the impression that they do not understand my point. More likely is that the larger and less scrupulous foreign-owned firms on Cyprus are handing a brown envelope to the government each year which is a surefire way to ensure that the regulator ignores it.

As far as the ESMA rules are concerned, the pan-European directive, which mandates that, effective August 1, 2018, a restriction on the marketing, distribution or sale of CFDs to retail investors was introduced. This restriction consisted of leverage limits on opening positions, a margin close out rule on a per account basis, a negative balance protection on a per account basis; preventing the use of incentives by a CFD provider; and a firm specific risk warning delivered in a standardized way.

In particular, the leverage limits on the opening of a CFD position by a retail client vary from 30:1 to 2:1, according to the volatility of the underlying:

· 30:1 for major currency pairs;

· 20:1 for non-major currency pairs, gold and major indices;

· 10:1 for commodities other than gold and non-major equity indices;

· 5:1 for individual equities and other reference values;

· 2:1 for cryptocurrencies;

The margin close out rule now applies on a per account basis. This will standardise the percentage of margin (at 50% of minimum required margin) at which providers are required to close out one or more retail client’s open CFDs.

Bonuses, another extremely naff, and somewhat dangerous tactic used by lowbrow brokerages who confuse themselves with underworld online casinos, are also not allowed but of course as you can see by the conversation of this morning between the aforementioned retail trader and FinanceFeeds, they are still being offered as these companies cannot extricate themselves from the fruit market mentality of affiliate marketing, lead buying and bonus-based profit/loss revenue models as seen in the Middle East in the early to mid 2000s from MT4 firms owned by semi-literate former casino owners with shiny heads and thick accents, some of whom are now residing in penitentiary institutions and others wanted by authorities.

FinanceFeeds reached out to the broker concerned this morning for their perspective on this matter, but no answer was forthcoming. For those wishing to obtain further information regarding this matter, please contact FinanceFeeds.

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