Why does the FCA continue to license firms with absolutely no capital? – The alarming figures

Britain, home to the world’s largest and most stable institutional FX industry, as well as some of the most esteemed publicly listed retail brokerages, which adorn the banks of the River Thames alongside six FX interbank dealers which handle over 49% of the entire FX order flow at Tier 1 liquidity provision level, as well as some of the most historic prime of primes in the entire financial world.

London, by a margin the size of the Hoover Dam, is the capital of electronic trading, global markets and a powerhouse of sophisticated technology and infrastructure that powers the global financial industry.

Its regulator, by contrast, is impotent.

The Financial Conduct Authority (FCA) has only the quality of London’s plate glass, highly polished financial markets ecosystem to thank for its own glowing reputation worldwide, as conversely to most regions, the FCA’s good name comes on the back of the companies that it oversees, rather than the other way round.

Indeed, the FCA has zero restitution or criminal prosecution powers should something go awry (which is very rarely indeed in the UK, such high quality is the entire business and the talent base in which executives dedicate their careers to polished accuracy) then the FCA simply offers a firm to settle via fiscal means, at a discount, and not so much as a compliance inspection takes place.

To exemplify this, between 2010 and 2013, 97% of the £943 million in penalties issued by the FCA to firms in all sectors of the financial services industry were settled by this means, with no official even entering the premises.

Whilst many regions including North America and Australia, both home to some of the most stringent and advanced regulators in the world concern themselves with regulatory capital and are subject to continual surveillance, with the shadow of being shut down and having client funds restituted should they go outside the parameters, the UK continues to allow the metaphorical minnows to swim among the heavyweights, unchecked and without recourse, despite flagrant flouting of rules.

In Britain, CFD trading is very popular indeed, due to the tax treatment of spread betting products by the British government, hence the proliferation of proprietary platforms for this purpose, many of which are the subject of several million pounds worth of development and continual support to millimetric accuracy.

Others, however, are quite simply a fly in the ointment and are allowed to operate despite having absolutely no capital whatsoever.

A case in point is an electronic trading firm called City of London Markets, which is an investment management and stockbroking service, which offers retail clients a range of assets tradable via an electronic retail platform.

The emphasis of City of London Markets’ offering is CFDs, the company’s website alluding to CFD trading in a massive capacity, taking precedence over the other assets it offers which are shares, SIPPs and ISAs (traditionally British savings systems which are aimed at retirement planning via alternative investments), FX , options and futures.

The largest firm in this sector in the UK is Hargreaves Lansdown, which has a market capitalization of over £6 billion and is a bastion of quality.

One thing that the FCA stipulates in order to gain a license is that, contrary to popular belief, an applicant must state how much regulatory capital is required, with a minimum of 730,000 Euros, the lowest amount permissible under MiFID regulations. Aside from the MiFID requirement, the FCA acts rather like a self regulatory organization in that a firm must submit how much is required, and then when the license is approved, must stick to those self-determined parameters.

However, in the absence of any compliance inspections, transgressions are easy to get away with.

A look at City of London Markets’ accounts makes for interesting reading.

At 3.41pm on November 9, AIM-listed Milestone Group (MSG) slipped out a “miscellaneous” RNS on the FCA’s regulatory reporting site. It may have won two big contracts recently but in terms of this RNS, there was nothing miscellaneous about it: this company is in serious trouble.

One day later, after MSG detailed that £1.25 million from a placing announced on 20 October had gone west, the shares for which were admitted to trading on 31 October had not turned up, with the firm responsible, according to ShareProphets, being City of London Markets.

Yes, trading errors occur occasionally, however this particular incident is perhaps more alarming when considering that City of London Markets completed the year ended 30 September 2015 with a turnover of just £25,674. Despite regulations set forth by MiFID requiring a minimum of 730,000 Euros for a market maker’s license, City of London Markets’ annual report for September 2015 showed cash at the bank of just £1396. Quite how an order for 1.25 million can be settled and processed bearing this in mind is a mystery.

The firm made a loss of £25,928 and net assets stood at £41,955 but included within current assets under the description of other debtors was in fact an amount due from James Douglas for £46,628 (2005: £23,193). This is described as being interest free and with no fixed repayment date. James Douglas is named as the sole shareholder.

As far as this is concerned, it is quite alarming that the FCA continues to approve this company as having sufficient regulatory capital.

Unlike the Australian Securities and Investment Commission (ASIC), the FCA has no real time surveillance system and does not perform continual checks on its market participants in order to find such parameters, however considering that this information is publicly available under the filed accounts at Companies House – a requirement for all British companies – it would not be difficult for compliance officers to go through the records and root this out.

Today, regulatory reporting technology is the new wave of FinTech that is making for a more advanced regulatory environment and helping brokerages conduct their business more efficiently, however deducing this massive gap in risk being taken vs regulatory capital would really only require the low-tech approach of going through company accounts, and then sending a government accountant to check the real fiscal situation of the firm.

In Britain, no FCA regulated company has ever had its license removed or suspended for undercapitalization, whereas this is a massive bete noire of the American and Australian authorities, which regularly wind companies up or remove their licenses for inadequacies in net capital.

Indeed, the UK is the center of highly polished financial services firms, whose technology and prowess is world class, however in order to preserve its reputation, the sleeping giant that is the FCA should be woken from its slumber – preferably before a large exposure makes itself known rather than as a reactive measure.

Caveat Emptor….