The FCA, the British margin advantage and why MT4 brokerages have never been able to list on public exchanges

What has owning your own trading system got to do with new margin regulations by the FCA? We investigate from London, and look at why MetaTrader 4 could be a victim of its own ubiquity.

The imminent demise of the MetaTrader 4 platform has been met with some surprise, some skepticism and in FinanceFeeds case, more than a degree of criticism as to the way the ubiquitous third party platform that dominates the small to medium retail FX brokerage space is being decommissioned.

The platform monopoly may well be at its legacy software orientated nadir, however apart from a will to finally move brokerages onto the newer (although still hardly a spring chicken) MetaTrader 5 platform, there has to be far more than meets the eye.

Until now, MetaQuotes has had something of a stranglehold on a market that was largely empowered by its own easy-to-set-up third party solution, that being smaller brokerages in peripheral regions to the main financial centers of the world, whose owners do not wish to invest in research and development or in house support, and simply want to advertise, and sell to retail traders.

Why, with such a monopolistic business environment, would MetaTrader 4 suddenly prepare to shuffle off the electronic coil?

One particular reason could be the current plethora of infrastructural requirements and changes that are being instigated by regulatory authorities across Europe, largely as a result of the stipulations within MiFID II, set out by the European Securities and Markets Authority (ESMA), and their pending review of the CFD space.

At a cursory glance, it may appear that any link between regulation aimed at brokerages and the ability for a liquidity and client agnostic software platform would be very tenuous indeed, however there is much more to consider than a situation in which a broker’s compliance and trade execution divisions are mutually responsible for compliance with regulations.

Dan Moczulski, CEO, Star Financial Systems

This is because MiFID II is exactly as its acronym implies – an infrastructure directive, hence it impinges on software code that makes up the fabric of a platform, and in the case of MetaTrader 4, the original code dates back to 2004, which in any computer software lifespan can be considered way more than simply legacy. The proposals for auto close out, and importantly close out by position are at odds with how the industry currently works.

A recent communication by the Financial Conduct Authority (FCA), itself under great pressure from ESMA to mitigate exposure to negative client balances by providing every broker with a market maker’s license requiring brokers to set aside 730,000 Euros in regulatory capital, as opposed to the non-dealing desk license that requires 125,000 Euros in regulatory capital thus showing ESMA’s apparent lack of thought in that by doing this, it encourages the non transferral of trades to a live market, margin us under the microscope too.

In its assessment, the FCA found that in conditions of standard market volatility, a client is likely to make a loss due to automatic margin closeouts set by the brokerage firm. The FCA considers this to be an issue because brokerages typically set their margin closeouts at 50% of the initial margin posted, with a leverage ratio of 500:1, a 0.1% fluctuation in the price of an instrument is all that would be required to trigger an automatic close out of the client’s position.

Career civil servants in mainland Europe may be about as au fait with sophisticated electronic trading solutions in developed financial markets centers such as London, New York or Chicago as an eskimo is with a bathing suit, this ruling demonstrating the perceived safety of client assets being created at the expense of brokers having any reason to trade in a live environment – in layman’s terms, it encourages the B-book.

Speaking today to Daniel Moczulski, CEO of Star Financial Systems in London today, FinanceFeeds discussed how the margin close out rulings may well be of benefit to British brokerages, and indeed large companies with their own proprietary platforms, but could well have sealed the fate of MetaTrader 4’s cul de sac.

“ The proposals suggest that the increased margins requirement, and any subsequent close out needs to be applied on a by position basis, rather than on an account basis. Let’s say you have a Dow position that requires initial margin of $1000, and the regulators say that the auto close out should occur when you’re 50% down, which would mean that it would be invoked if the trader is losing $500, even if the trader has another free $35,000 on the account then he will still be closed out. The trader needs to have explicitly committed extra margin specifically to that particular position.”

“The proposed rules state that the trader has to specify that he commits a specific amount of margin to that individual position, the broker cannot just assume it” said Mr Moczulski.

“The critical matter here is that most platforms that exist currently do not work in that way. Most work by managing a margin across the whole account” – Daniel Moczulski, CEO, Star Financial Systems, London

Moczulski however says that it wasn’t always this way. Non MT4 UK brokers are fairly familiar with the idea that stop losses alter the margin requirement a position needs. Auto Stops, Non-Guaranteed stops and guaranteed stops with several brokers influence the amount of margin required, hopefully addressing the ESMA Proposals.

“Lets take a guaranteed stop loss as an example. Let’s say you are a trader that does a lot of FTSE trading and you want to risk $1000. You buy the one contract of the FTSE, put the stop loss at 100 points away, therefore the risk is £1000. If you then move the stop loss to £2000, or 200 points away, you would have to then advise the broker that you would need to commit that amount to margin” he said.

“Using a guaranteed stop loss is one way brokers could resolve this issue is by, hence many British brokers could well have an advantage over others as they are very familiar with guaranteed stop losses” he explained.

An interesting point to consider here is that MetaTrader 4 could be coming to its end largely because perhaps it is too much of a legacy platform with too much legacy coding that cannot be picked apart to cope with all these changes. This is not something we know of, but it is entirely possible, as the nature of the regulatory changes recently has been very dramatic and landscape-changing, thus, a for a third party platform to have remained in dominant service for this long since 2004 is remarkable indeed.

Mr Moczulski responded to this by explaining to FinanceFeeds “A particular reason why this is interesting is that I believe that we can solve the problem, as before MetaTrader 4 existed, it was very common to charge margin based on where the stop loss was set. If a trader put the stop loss a long way from the margin then a broker would charge more margin, and if it was nearer the market, then the broker would charge less margin.”

“Because Star system has that mechanism built into it, I think we can offer this to brokers. The devil will be in the detail with regard to what ESMA will come out with long term, but currently having studied their paperwork, it looks as though this is the case” he said.

This brought up a subject that FinanceFeeds has considered of great pertinance to retail brokers today, that being the need to be in control of their own destiny and own their infrastructure.

“The imporance of platforms to brokers should not be underestimated” said Mr Moczulski. “Star Financial Systems separates the trading interface and the actual middle and back office that supports it. Therefore, if I look at our clients, I can see that we have brokers that are using MetaTrader 4’s trading interface only, but are using Star Financial Systems’ middle and back office to manage their client bases.”

“Alternatively some of our clients use the Star Financial Systems trading interface that we customize to effectively be their own platform, and then use our back office and middle office to manage their customer databases” he said. “This gives flexibility in managing customer data in a familiar and transferable environment, yet allows brokers to have the all important proprietary platform that creates loyalty among traders and differentiates each broker’s service.”

“We also have brokers who have actually built their own trading interface and it sits on Star Financial Systems’ own back office. When brokers get bigger and want to scale their enterprise, they want to own their own system. They can build their own, and can optimize it to their own client base whilst basing it across our brokerage solution infrastructure” said Mr Moczulski.

Looking at this from an intellectual property and corporate value perspective, it is perhaps no surprise that no MetaTrader 4 brokerage, even a very large one, has ever been able to float on any stock exchange.

One of the factors that may have contributed to this could well be that it is very difficult to float a business that has all of its client base on somoene else’s technology and infrastructure.

Mr Moczulski then looked at multi-asset diversity and the need to have an adaptable infrastructure in these changing times.

“If for example a client wants to offer a different platform altogether but not have to be tied to the vendor’s full solution, this can be done. With NetDania for example, which provides an excellent quality platform that copes well with the demand of professional traders, the NetStation system sits on the middle and back office of Star Financial Systems, and we can send all trades to market directly so that it becomes liquidity agnostic” he said.

“We can have up to 50,000 markets on the system so it was never designed to be restricted as purely an FX platform that’s been adapted over time to having equites and commodities engineered in, it genuinely understands all markets that are being pushed through it” explained Mr Moczulski.

Brokerages in established jurisdictions which have invested in their own trading solutions therefore are in a position of sustainability, and are also in a good position to approach the US market, a move which FinanceFeeds considers to be a very good one, and at an opportune time.

With very little competition and an astute, highly sophisticated domestic client base, America’s trading environment is the antithesis of the MetaTrader 4-based retail sector in Europe or Asia, and requires a stable firm with a solid and recognized product range, hence now is the time to consider this seriously.

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