End of the FX IB in Australia? ASIC takes major bank to court for unregulated referrers

Regulatory harshness has become something of a thorn in the side of many retail FX brokerages in the well organized, highly developed Australian capital markets sector.

During recent years, the Australian Securities and Investments Commission (ASIC) has shown its mettle by conducting real time surveillance on the activities of electronic trading firms, something that many other global regulators are unable to do due to their lack of technological acumen and absence of a comprehensive understanding of how the OTC derivatives business works structurally.

The regulator has also shown its intent by closing down certain firms for not acting in the best interests of customers, making a very concise research on the method by which trades are executed and how retail traders can be given a fair and genuine approach to a live market, and most recently, introducing draconian proposals which aim to change the method by which CFD products are distributed to Australian customers.

One of the most important factors to consider is that Australia is home to one of the most professionally run and highly sophisticated retail trading environments in the world, and is recognized as such globally, hence in some respects, ASIC’s moves have been unsolicited and are not reactive to very much other than to demonstrate their power to a retail client base that is already accustomed to good quality.

This week, however, ASIC has gone one step further. The regulator has already prevented brokerages from onboarding non-Australian clients so that it can deal with implementing its stringent rules on its own shores without circumvention, however now ASIC is taking a very strong aim with a very sharp arrow at the introducing broker (IB) business.

IBs have been instrumental partners to most FX brokerages worldwide for several years now, especially during the rise to prominence of the MetaTrader 4 platform in the first decade of this Millennium, when affiliate relationships were considered more efficient in terms of client acquisition than individual traders and customer service was considered easier to manage with IBs acting as local representatives in specific regions, often with a loyal client base.

Whilst affiliate marketing is a bete noire of most sensible people – and rightly so – IB networks can prove absolutely essential, very efficient and add that extra important bit of local knowledge and customer service, hence their popularity among most successful brokerages.

Indeed, the majority of high revenue generating retail FX brokers which do not have their own infrastructure are reliant on IBs for their trading volume.

For example, CMC Markets and IG Group, both long established, publicly listed firms with their own very refined trading infrastructure have a long term, loyal direct client base in their home market of England, and a substantial self-directed trader client base in Australia.

On the other hand, IC Markets, an Australian brokerage which relies completely on third party infrastructure and is MetaQuotes’ largest customer with over 20 servers and generates revenues of over $500 million per month, is a MetaTrader 4 brokerage whose revenue comes mostly from South East Asian IB networks.

Australia’s authorities clearly do not approve of this method of doing business, and this week have gone to court with National Australia Bank (NAB), one of Australia’s largest retail and commercial banks in order to seek legal recourse over commissions paid to what ASIC deems to be ‘unlicensed IBs’.

Going after a major bank is a bold move, but it sets out the picture for the future. If a major bank can find itself in court for paying commission to ‘unlicensed IBs’ it sets a very substantial precedent for doing the same to retail brokerages, most of which do not have the resources or the litigious substance of massive institutions such as NAB.

It also shows that ASIC is interested in – if you’ll excuse the pun – nabbing a bank so that it sends the message that if a big bank with a clean copybook can find itself in front of a judge, then it will be easy to do this to brokerages.

ASIC’s beef is that NAB paid $1 million in commissions to unlicensed home loan “introducers” who allegedly overstepped their role and gave the bank detailed customer information, and has taken this to court.

After the regulator launched action against NAB in August this year over its introducer scheme, a document filed in the Federal Court this week provides new details on the sums of money the bank paid in commissions.

In a case that could inflict a hefty fine on NAB, the Australian Securities and Investments Commission (ASIC) is arguing the bank broke credit laws in relation to 297 loans which were arranged after referrals from introducers.

Under Australian rules, IBS are allowed to refer clients to a financial institution, but they can only pass on the client’s name and contact details, as they do not hold a credit licence. Any handling of client accounts or being privy to what type of business, level of funds, account activity and balance details are not allowed into the remit of an IB, however most FX IBs know all of this information, and many actually trade accounts on behalf of clients.

ASIC is suing NAB because it says in these cases the introducers went further and provided documents including completed loan applications, tax returns, and even false payslips in some cases.

This translates to a similar modus operandi in FX.

The existing, soon to be previous model, has been such that the IB brings a client to the retail electronic trading firm and that client is then tagged under the IB relationship .

On going trades generate commissions, which are split with the IB for the life of the client and the IB can monitor ongoing trades to track IB commission.

An IB could be someone very active within the dealings of the client, he could even be trading for the client (which maybe constitutes a conflict of interest) or he could just be a simple IB that brings a client and has no further dealing or interaction.

In the case of NAB, ASIC filed a document with the court that shows the commissions were typically worth a few thousand dollars per loan, though the largest payment was $29,700 for a loan drawdown in 2015. In total, the commissions paid by NAB that are listed in the document are worth slightly more than $1 million across the 297 loans in question.

Federal Court Justice Michael Lee this month gave orders for ASIC to file the document, which has customers’ names redacted.

NAB formally closed its introducer scheme this month, after interim chief executive Phil Chronican earlier this year said axing the program was the “right thing to do.”

NAB’s chief customer officer for consumer banking, Mike Baird, said: “As this is before the Federal Court, we are not able to comment on the specifics of the case. However, what we can say is we were the first major bank to cease our introducer payment program and have run a comprehensive remediation program for impacted customers.”

The businesses listed of as receiving the commissions from NAB include a range of real estate and investment firms. The royal commission, which revealed explosive evidence of misconduct in NAB’s introducer scheme, last year heard that at least one gym owner was also at one point bringing in business for NAB as an introducer.

The alleged breaches by NAB attract a maximum penalty of $1.7 million to $1.8 million per breach, which adds up to a maximum penalty of more than $500 million. However, ASIC has said this is “well beyond” the penalty a court would actually impose.

Translating this type of structure to that which is very standard practice in the FX business is quite simple.

Looking at how most FX IB commission structures work, quite often an IB agrees with CFD/FX firm to mark to the client account by a agreed amount say 1 or 2 full pips.

So if the market on the Dow is 25520-25521 the the mark up will show 25520-25523 ( 2 pip mark up ).

Example client opens $10 per point on the Dow. Normal spread paid = 25520-25521= $10 per point so $10 paid in spread

Mark up: 25520-25523 = 3 pip spread, and the client pays $10 per point pays $30 spread

Of the above $20 goes to the IB and $10 to the retail FX firm, hence my stipulation that those extra pips go to the IB.

Structures like this require continual monitoring and involvement by IBs in their customer’s activities which is one of the things that has led NAB into hot water.

Additionally, the conflict of interest in terms of mark ups, or attempts by brokers to make clients lose which are in the interest of IBs that use a profit and loss commission scheme are well on the radar of ASIC.

Perhaps, as in the 1980s when financial products were delivered on pieces of paper by a man in a pinstripe suit and a briefcase, the method of remunerating today’s IBs could be a fixed fee rather than commission.

Should brokers choose to move to that method now voluntarily, it will help them sustain their business when the regulator comes along and puts a stop to the current model. If they do that, they may simply say “No more IBs” whereas if a fixed monthly retainer is in place, and brokers are the only entities privy to client activity, all should be fine.

For further information on how to build good quality IB networks and select the right IBs for your business, please contact FinanceFeeds on [email protected] as we are experts in that sector of the business globally.