The days of the bucket shop are numbered

Research carried out by FinanceFeeds over recent months has drawn a very interesting, and actually very promising indeed, that being that the regulatory structure in some of  the most prominent and popular locations for retail FX is now so well organized that firms that are unable to cope with the demands of the regulators are, of their own accord, packing their bags.

Until just five years ago, Britain and the United States were home to the most established FX and electronic trading industry, both nations being, as they are today, financial powerhouses with the most respected regulatory structures in the world.

Of course, as with any large industry, there have been cases of companies that have created cause for complete regulatory overhaul, the demises of MF Global and Peregrine Financial Group (PFG) being cases in point, for which very comprehensive regulatory action was taken, and indeed North America’s reputation as a top quality jurisdiction very well preserved.

With the onset of increasing popularity of retail FX trading came the establishment of many smaller brokers which did not have the capital or wherewithal to set aside $20 million in net capital to satisfy the National Futures Association in the United States, or spend a year going through due diligence qualifications with Britain’s Financial Conduct Authority (FCA) and then paying salaries for highly qualified professionals in London, most of which exceed £80,000 per annum for a good sales executive.

In some of the more prestigious streets in central London, rent averages £85 to £100 per square foot, making a 4,000 square foot office (about average for a medium sized FX firm) cost anything upwards of £340,000 per month, which is not even a consideration for startup brokers on a budget with a $5,000 MetaTrader 4 white label license.

This is where Cyprus comes in.

Cyprus is a former British colony, with a very high standard of living, an educated population and low corporation and income taxes, and has, over the last five years built up such a vast retail FX industry that the entire ecosystem, including over 180 retail brokerages (out of the world’s 1231 active MetaTrader 4 firms).

The Cypriot regulator, CySec, encouraged the industry to flourish on the island, with great success, and it has now been possible for quite some time to establish a fully operational brokerage with packaged regulation, integration and MetaTrader license via one of Cyprus’ specialist law firms.

The main attraction, as opposed to other tax-friendly regions, was that Cyprus is a member state of the European Union, therefore CySec has the passporting agreement via MiFID, which places its regulatory scope and ability to attract global clients on a par with that of Britain, but with a fraction of the costs and administrative procedure.

Five years, however, is a very long time in the fast moving retail FX industry, and with startup firms that had good intentions, many of which have prospered today to their credit, there were a series of companies that just wanted easy and flexible regulations in a region that was attempting to encourage the industry to grow whilst still in its infancy with regard to capital markets regulation.

Cyprus has long been a tax haven and a very popular (and quite spectacular) holiday destination or lifestyle choice for expatriates from Britain and Russia, however the rapid move into a very developed capital markets economy required equally rapid evolution of regulatory structure.

CySec rules becoming too tough for some. This is great news for the good quality companies

Last year, CySec began suspending licenses of firms that were not meeting the required standards stipulated by the regulator, which represented a sea change in regulatory prowess, however this year, a totally new dynamic is appearing, which means that CySec is doing its job very well indeed, and also that good firms can prosper, Cyprus’ longevity as the number one destination for retail FX will be preserved, and the ‘bucket shop’ will be gone for good.

CySec’s remit is to ensure that firms operate in accordance with appropriate rulings and uphold a standard. The regulator, like many other regulators around the world including ASIC in Australia (one of the very best regulatory authorities worldwide) and the FCA in Britain, does not have restitution powers and cannot sue companies for misconduct.

Instead, it can set rules and ensure licenses are only maintained if such rules are followed – the ombudsman and the courts are the outlet for individual or class action grievances.

FinanceFeeds has noticed a very interesting dynamic as a result of CySec’s honing of its regulatory structure and more stringent approach of late, that being that firms that are either unable, or not willing, to adhere to the regulations are rescinding their licenses and carrying on business without regulation, in frontier jurisdictions.

This is an increasing dynamic, and if monitored correctly by the regulator, will ensure that only firms which operate with bona fide intent, and have sustainable client bases will be able to prosper, with the assistance of good quality regulatory backing.

The firms that are rescinding licenses are those which are smaller, less well known and have clients in frontier regions with no local regulations, such as the Indian Subcontinent including Afghanistan and Pakistan, as well as Africa and certain parts of South East Asia where markets are less well organized than in other regions and clients have less understanding and little recourse if something goes awry.

Very good news for Cyprus, and for LPs and PBs wishing to work with brokers, and vice versa

This is very good news for Cyprus, and for this type of attrition, CySec has to be commended as it is clear that the regulator is succeeding in ensuring that those not adhering to rules figure this out for themselves and leave.

Not only is this great for existing brokerages in Cyprus, but also for prime brokerages and liquidity providers wanting to onboard good quality retail brokerages as clients within Cyprus.

Many primes have very strict reporting rules, very detailed compliance procedures and are subject to credit restrictions by banks, therefore the modus operandi of firms that they provide services to is paramount, as is the execution model and how order flow is conducted.

CySec speaks to FinanceFeeds about strong regulatory boundaries

Two weeks ago, FinanceFeeds spoke to CySec, at which point an official spokesman explained “Firms looking to cheat the law have no place in Cyprus. CySec will continue to uphold its commitment to making sure those licensed in Cyprus do so in full compliance with the necessary European Directives and the national legislation, which are designed to protect investors.”

CySec explained that “To put this in context, we are conducting an investigation which is part of a wider thematic supervisory review into the investment firms, inclusive of those CIFs which offer trading in forex and financial binary options. CySEC’s risk-based Supervisory Action Plan prioritized 20 Cyprus investment firms for inspection, where a series of in-depth onsite checks were carried out to ensure market procedures, governance and risk processes, client onboarding and suitability requirements, and AML procedures were being complied with.”

Bearing this in mind, cancellation of CySec license by brokerages that find the rulings too strict, is occurring of their own accord.

The moot point, of course is a firm that is long established in Cyprus that has been the subject of a series of high profile media campaigns – IronFX. With regard to this, following CySec’s ussing of a 335,000 euro fine last year, the regulator stated “IronFx has been and continues to be under close monitoring to ensure that all corrective measures are duly implemented and second that it will continue to duly comply with its obligations under the Laws governing its operations which fall under the supervisory competence of the CySEC.

This direction was recently alluded to during a speech by CySec Chairman Demetra Kalogerou at the iFXEXPO International conference in Limassol in late May this year, the full dialog which can be read here.

Now, with New Zealand having removed over 300 entities from its FSP Register that do not have physical offices in New Zealand and are not able to meet the standards set forth by the Financial Markets Authority (FMA), and CySec having made such leaps forward that only reputable firms will be able to operate, we can look forward to a future in which the major regions for the retail FX industry – Britain, Hong Kong, Singapore, North America, Cyprus, Australia and New Zealand, can encompass a structure of liquidity providers, prime brokerages, retail trading companies, software providers and ancillary vendors in the safe knowledge that these regions will be home to the most sustainable business in the world for the electronic trading industry.

Those which cannot, or do not, wish to operate according to a bar that has been set high among these first class regions, will find their homes elsewhere in the world, making it an easy choice for traders as to which regions to do business in.

Photograph: Limassol Marina, Cyprus. Copyright FinanceFeeds