Leverage restrictions, binary bans, Google and Facebook ad blocking: Time to raise all standards. FinanceFeeds Analysis

This morning, the European Securities and Markets Authority (ESMA) dropped its latest bombshell onto the retail FX and CFD industry.

Whilst the passing of such a ruling has created a tremendous furore within the entire electronic trading community worldwide among both brokerages and traders, it is important to take stock and consider the dynamics and implications of ESMA’s proposals.

This morning, FinanceFeeds reported that under the new rulings, leverage for CFDs will vary from 2x to 30x depending on the underlying, with the strictest leverage cap to be applied to cryptocurrency CFDs.

Immediately after ESMA’s implementation became effective, Britain’s Financial Conduct Authority (FCA), which presides over the lion’s share of global institutional and prime of prime brokerages as well as some of the world’s most prestigious publicly listed retail FX and CFD firms, stated in a brief comment responding to the measures outlined by ESMA, that it is supportive of the proposals and is now entering consultation as to whether to permanently adopt ESMA’s restrictions on CFD leverage which are currently temporary proposed intervention measures.

This morning, here in London, FinanceFeeds has researched the inside view on the proposals, having met with several senior executives from brokerages and also from mainstream financial analytical and benchmark media entities that provide services to British financial institutions for research and analytics to discuss this matter in detail and of course to air our own opinion.

Currently, with what appears to be a very sudden and draconian change in trading conditions for many market participants having been foist upon every firm that operates under the European Union’s jurisdiction, it is important to take a step back and look at the implementation of restrictions in other regions and how it was received, along with the subsequent effect it had on how brokerages do their business.

Admittedly, the retail FX sector did not resemble its own makeup of today just five years ago, however when the Japanese FSA implemented its leverage restrictions back then, a large proportion of brokerage executives had watched in anticipation, waiting for a complete decimation of a totally domestic market, conservatively operated and dominated by trillion-dollar-per-month volumes by vast domestic companies.

The decimation never came.

Speculation at the time included views that Japanese traders who were used to very high leverage provided by large and reputable Japanese companies would rue the restrictions and not be adaptable enough to begin to stump up more invested capital, and that the Japanese obsession with retail FX would make its way over the borders and into the sights of Western firms.

Here we are, some five years later, and Japanese business still represents over 35% of all global retail FX order flow, all handled by the same Japanese FX firms that were subject to massive leverage restrictions.

No Japanese IBs closed down all their customers’ accounts and moved them en masse to overseas firms, and no self-directed Japanese retail trader eschewed DMM Securities, MONEX Group or GMO Click.

This demonstrates that a quality customer base which is used to a quality retail provider will simply up their margin and carry on, rather than face the pitfalls of playing into the wide open mouths of the sharks of the Middle East, Central Asia and their shell companies in the Caribbean Islands.

Looking at the Japanese customers’ reception five years ago to the leverage restrictions could be a good precursor, however in Western regions which are populous with FX and CFD brokerages, the structural makeup of the companies vying for retail business differs tremendously in that there are effectively three types of retail firm.

There are large, publicly listed companies with London offices, their own highly well developed in house trading systems and market capitalization reaching into the hundreds of million, then there are the small, MetaTrader white label brokers in Cyprus which have a skeleton staff and all of their main operations including owners and client fund accounts outside the EU, then there are the professional trading platforms that provide futures and derivatives, that are now looking toward an international retail audience.

It has been a widely held perception that large British firms have a stranglehold on the London commercial landscape and that their lobbying power when it comes to ensuring non-compliant companies from overseas do not pervade their territory, however whether this is the case or not, it is FinanceFeeds opinion that more lobbying needed to be done.

A strong effort to differentiate the bona fide from the chancers with no real remit to be operating in organized countries with good quality consumer environments and an expectation of quality by our own industry participants would have achieved two potential outcomes.

The first would be to make a clear distinction in the minds of Google and Facebook’s digital advertising network executives and the Millennials that operate their pay per click schemes and advertising networks so that those twenty-somethings with a beard that looks like an upended Box hedge whose expertise is in digital marketing and not financial technology.

As the regulators and search engines do not know the difference between a prestigious London firm with a 30 year history and a two-man effort in the Seychelles whose remit is to steal money and look official with scant CySec licensing and minimal/temporary physical operations, it is up to us to continue to push the powers that be to understand. This would mean that ad bans and trading restrictions would only apply to those who have no intention of longevity or whose executives come from gaming and lead buying/stealing instead of the genuine financial sector in the civilized world.

As it now stands, the natural selection will likely begin post-restriction.

Speaking to a very widely recognized financial reporting and analytical entity in London this morning, opinion was  that there will likely be a consolidation of business within the European Union, leaving a situation rather like that of the United States post implementation of the $20 million minimum capital adequacy requirement which is heavily policed by the NFA.

This means that CMC Markets, IG Group and Hargreaves Lansdown will continue to dominate in the UK. Their customer bases are over 70% British in the cases of CMC and IG, and 100% British in the case of Hargreaves Lansdown.

Customers of that caliber who are loyal and appreciate the quality of their providers will stomach the leverage restrictions and continue as normal, whilst smaller firms that cannot hack it, will pull out.

IG Group is a case in point. With just two companies in the US domestic market, IG Group is reopening its business in Chicago, demonstrating that it is a company that wishes to operate according to the most stringent rules and onboard very high quality customers for a long term business strategy.

One CEO of an FCA regulated medium sized brokerage this morning told FinanceFeeds “I am not sure that ESMA is doing enough to protect EU clients. I guess the decision is to protect the EU retail markets, but, what will small traders who prefer leverage 1:500 do? Yes of course 30x is more than enough, but not for the ones with a great risk apetite. When looked at like this, it defeats the purpose of ESMA protecting clients as retail clients will send their funds offshore in a non controlled environment”

A compliance officer in the City responded to this by saying “I doubt there will be a substantial push to offshore, since the big firms have EU and non-EU licenses and they won’t onboard an EU client offshore. Who are you going to go to? Australian firms like IC and Pepperstone have EU entities or getting them. It will be interesting to see how volumes are effected by leverage change.”

The natural selection will extend toward the type of client attracted too. The days of small firms trying to churn recycled leads that have been taken by sales staff from small broker to small broker to be used for aggressive attempts to extract $200 from already jaded individuals in Africa, the Middle East and Asia will go.

This can only be a good thing, and it will lead to companies having to raise their standard, and by doing so realize the folly of the current digital marketing, lead buying and churn and burn nature of so many small CySec firms.

In Britain, there is some clamor in the City this morning (during my breakfast among several industry execs) about a potential requirement that the license may have to be upgraded to a full market maker license requiring 730,000 euros regulatory capital adequacy in case the A-book license is done away with, however in FinanceFeeds opinion that would be detrimental to best execution requirements as it could encourage more internalization of trades.

The leverage cap will force those who stay and go the distance to look for clients with $3000 deposits or upwards, thus going after a higher quality of client with a longer lifetime value, via channels that are more effective than the old fashioned media buying method.

Google and Facebook’s blanket policy of disallowing certain advertisements for FX and cryptocurrency related services is a prime example of why a self-generated effort do differentiate between types of companies so that the uninitiated regulators and pseudo-controllers of the internet – Google and Facebook – are able to make proper decisions instead of block everyone, thus categorizing the good as worthy of penalization as the bad, and in some cases the ugly.

By excluding scammers with vast marketing budgets and a bullying mentality from important industry conferences or from industry websites (both of which are scanned regularly by the authorities to look for associations – I have that on VERY good authority – Ed) the distancing of binary fraudsters from Ramat Gan from highly educated industry leaders from the Square Mile who have dedicated their careers from private school to top level university to very difficult internship to leadership of 4000-strong companies with shareholder reporting responsibility would be easy for those in the grey cardigans at their desks at ESMA headquarters and equally easy for the twenty-somethings with facial attachments that would repel even a large magnet.

The imagery portrayed by the low end has often been very loud and blatant, with vast banners everywhere, and massive presence at offline events. This has been detrimental for these reasons.

Now, brokers should look away from wasting money on ad networks in Google, or PPC campaigns. This is not a lead sourcing or conversion business, it is a financial and technology business therefore now with the network restrictions and the leverage changes, brokers will be forced to move away from that gaming-inspired model which is expensive and ineffective, does not raise the quality of clients, and has no longevity.

Instead, high-touch models will be required via offline events with customers meeting their brokers, more reliance on IB relationships and more educational and resource-related means of onboarding customers will reduce the cost, lengthen the term of client lifetime, and up the deposit amounts leading to much higher assets under management for brokers.

Working closely with proper media rather than running random campaigns on Google network, removing the CPA model and looking for higher net worth clients will now be a dynamic that has been implemented by circumstance, but will build brokerages toward a far more sustainable future.

Let’s face it, there is no retail FX business across most of the EU – it is London and Cyprus, both for very different reasons and with different business models, thus maintaining Britain’s outstanding reputation and loyal client base will be easy, and those wanting to show their global retail clients from South East Asia or the Middle East that they are genuinely regulated and ready to adhere will have to adopt a more London-like business model.

This can only be a good thing.