MiFID II: Entering the age of the completely self directed traders, as the final nail goes into the copy trading coffin

Britain’s Financial Conduct Authority (FCA), despite its glaringly outstanding shortcomings, is recognized globally as the most prestigious non-bank financial markets regulatory authority.

Indeed, it may well be, as is FinanceFeeds opinion, that its reputation was not earned via its own regulatory and jurisdictional merit, but by the high quality of the companies that operate in Britain, and by Britain’s first class, world dominating business environment.

Either way, whether a byproduct or not, the FCA is the flag that flies over much of the respected element of the retail FX industry, its benchmark status resonating across the globe, including in the all important mainland China, where MAM accounts and portfolio management are the mainstay, and self-directed trader are very much a rarity.

In today’s post-social trading era, those who developed their systems themselves and garnered a loyal client base that appreciate highly advanced proprietary trading platforms and completely integral trading environments as provided by the vast majority of British FX and CFD firms, many of which have been in establishment for three decades, will be the driving force.

This is because said companies made their investment into developing solutions that would engage and retail retail traders which are largely based in their own domestic markets.

From that basis, those companies built their reputation and now, as a result, large retail FX portfolio management companies that refer large volume and high values in terms of client assets under management generally use Saxo Bank, FXCM UK (most of this business is nowadays handled by FXCM’s mainland China division), GKFX, CMC Markets and GAIN Capital, which owns British CFD firm City Index, which is where most of this type of business had been placed.

A diverging factor is about to drive a massive wedge between firms whose traders are self-directed, and those which do not appeal to large professional overseas portfolio managers, as small scale Western market orientated social trading, already a dying effort, has become a focus of the new MiFID II rulings.

The Financial Conduct Authority already stipulated two years ago that social trading and copy trading is an activity that should require ‘lead traders’ – those whose trades and signals retail traders on copy trading platforms and social trading networks follow – to qualify and be regulated as investment managers.

This ruling, which was made part of the FCA’s regulatory remit in May 2015, has been a very silent ruling, with no companies having been taken to task over allowing unqualified or amateur retail traders to execute trades which are then ‘mirrored’ by an automated system to execute trades on behalf of other traders.

Largely, the focus has moved away from copy trading by regulators, just as it has by large, established companies, as social trading was a fad that rode the ‘social everything’ trend that prevailed in many electronic and online business sectors at the beginning of this decade.

Mostly all of the providers of social trading have disappearedFxPro shuts down social trading service SuperTrader, and those remaining have reduced to a shadow of their former selves, with the exception of eToro which operates in a completely different manner to its peers.

As firms continue to offer social trading and copy trading services, albeit on a much lesser scale than just a few years ago, the FCA has allowed trading volume to be generated via the automatic execution of trades to continue thus far, however as the January implementation of MiFID II approaches, the need to register as an investment manager with the relevant competent authority will be enforced.

This means that all companies offering such a service will have to ensure that every lead trader passes portfolio management examinations and registers as an investment adviser.

A question that has very rarely been asked, and is often overlooked centers on how likely amateur traders that gain commission from retail brokerages and social trading providers by becoming ‘lead traders’ are to be able to pass such exams and be in a position to act as an investment manager, and report their activities in such a capacity.

Bearing in mind that the vast majority of such individuals are based in developing market jurisdictions, are not professional traders or wealth  managers, and are using social trading platforms in order to gain commission for generating extra deposit revenue for B-book brokers which then use a profit/loss model and split the inevitable losses between introducer, lead trader and brokerage, the exact conflict of interest that the regulators are attempting to remove from the retail market.

When MiFID II is implemented, Article 19(1) will be invoked, which establishes that the overriding obligation for investment firms when providing investment services is to act “honestly, fairly and professionally in accordance with the best interests of its clients”.

Therefore, the European Securities and Markets Authority considers that when a firm offers the possibility to deal in financial instruments which have other products (commodities, financial indices, currencies, etc) as underlying, then, depending on the exact circumstances, it is likely to be artificial, and contrary to the overarching obligation of the firm to act honestly, fairly, and professionally, to make a distinction between advice regarding the underlying products of a financial instrument and that financial instrument.

In this situation, the underlying product of a financial instrument and that financial instrument should be regarded as a whole and any personal recommendation, for example, about the underlying product should be regarded as investment advice within the meaning of MiFID.

This ruling puts the vast majority of small, amateur traders who are operating as trade leaders on social and copy trading platforms completely in breach.

Where continental regulatory rulings lead, aligned jurisdictions such as the FCA will follow, the FCA already having stated its intention to operate alongside the MiFID II rulings, and bearing in mind the complexity and conflict demonstrated here, it is very unlikely that a lead trader in a developing market who has been encouraged by a b-book brokerage to bring his network of friends and acquaintances on board and receive a commission for trading their accounts, would be able to be aligned enough with the fund management sector to be able to pass exams and become an accredited portfolio manager.

This can be regarded as something of a cleanup, and will likely leave the large firms that have garnered a strong, loyal and empowered organic self-directed audience of retail traders in bona fide jurisdictions who choose their company based on trading environment, business prowess and execution quality to prevail and operate without hindrance, along with the large portfolio managers in China who provide vast amounts of automatically traded business to them.