“New CySec rulings will squeeze already stretched retail FX firms” says Leverate General Manager Sami Mana
The big risk that faces the brokerage sector in the European Union is that there will be further consolidation in that many will close, and others will merge meaning that there will be less brokerages but the ones that continue to operate will be large due to consolidation” – Sami Mana, General Manager, Leverate
On November 30, 2016, the retail FX industry in Cyprus became subject to what was perceived as a set of new regulations as CySec distributed a circular dictating, quite rightly, that all CySec regulated firms should desist from providing bonuses on deposits to retail clients.
CySec stated “Cyprus Investment Firms must avoid the practice of offering bonuses that are designed to incentivise retail clients to trade in complex speculative products such as CFDs, binary options and rolling spot forex as it is unlikely that a firm offering such bonuses could demonstrate that it is acting honestly, fairly and professionally and in the best interests of its retail clients.”
This instruction was accompanied by a further message which detailed the lowering of leverage to 1:50, for similar reasons, those being to eliminate the “you against the house” mentality of some smaller retail firms, and to stop any exposure to negative balances should firms be processing highly leveraged trades to market.
The difficulty is that despite CySec quite commendably making these rulings, it has been brought to our attention that there are still many firms operating with high leverage and which are offering deposit bonuses, demonstrating one of two possibilities – either CySec is ‘showboating’ by issuing circulars and statements asking firms to desist from this practice, or brokers wishing to continue on that model do not respect the regulations enough.
Firms in jurisdictions such as America, Australia or the United Kingdom, if instructed to desist from certain practices, would do so immediately, even if it created a very significant conundrum for their business, because the law is the law and the consequences for flouting the rules would be grave indeed.
The rulings themselves are not new, contrary to the furore that ensued subsequent to the issuing of the instruction by CySec. This was simply an attempt by CySec to place emphasis on its wish to enforce the rulings.
During the course of the past month, in the wake of Britain’s Financial Conduct Authority’s issuing of proposals on lowering the leverage allowable by CFD providers, FinanceFeeds has been approached by several FX industry executives around the world who wish to gain perspective on how the brokerages in Cyprus will cope with the new lower leverage requirements.
Today, FinanceFeeds spoke to Sami Mana, General Manager at enterprise brokerage solutions technology provider Leverate, in order to discuss how the retail market will likely be affected.
Beginning with an explanation of how the rulings affect Leverate’s customers, Mr Mana said “It is very simple. The changes relate to the European Union region as all of its member states are subject to the EMIR and MiFID rulings, meaning only our clients in the European Union regulated markets are affected.”
“Our client base is diverse in that we do not just have clients in the European Union but also in Asia, Africa, the Arabic world, and Latin America” continued Mr. Mana.
“As a result of the global distribution, we did not see a decrease in volumes and cannot see yet that the volume of our regulated clients is going down. Most of our larger clients that are based in the European Union clients are not doing volume with us, thehy are mostly taking technology solutions only” said Mr. Mana.
A matter that occurred to FinanceFeeds is with regard to how order flow can be conducted via liquidity bridges and liquidity management systems with regard to ensuring that brokerages in Cyprus can forge good relationships with liquidity providers when providing lower leverage and therefore lower trading volumes for the commission businesses of liquidity providers.
On this subject, Mr Mana said “On the liquidity provision side, we don’t feel the effect as most of our liquidity clients are not from the European Union region, with most of our market in that sector actually based in Asia”.
“That said, most of the changes are affecting regulated B2C firms, and are likely to in some cases break the back of not only small but large brokerages” – Sami Mana, General Manager, Leverate
“The new regulatory structure has become very stringent in terms of the monitoring and auditing of retail FX firms and CySec has been tightening up its regulatory stance” said Mr. Mana. “CySec began to give monitoring and auditing its firms much more value, and the European Securities and Markets Authority (ESMA) has been putting a lot of presure on CySec, which needed to become a serious regulator” he continued.
“CySec then began implementing existing rules and guidelines much more strictly, therefore a few months ago the profitability of brokerages began to be affected” said Mr. Mana.
“Currently, most retail brokerages are operating in a very low margin environment. Cost per acquisition (CPA) is very expensive, regulation is harder, companies cannot provide consultancy, and cannot use aggressive sales tactics towards retail clients” Mr Mana explained.
“This began to become a burden on brokerages in November, and the big risk that faces the brokerage sector in the European Union is that there will be further consolidation in that many will close, and others will merge meaning that there will be less brokerages but the ones that continue to operate will be large due to consolidation” – Sami Mana, General Manager, Leverate
Choking the market
Mr. Mana said that the regulatory environment is choking the industry and that if new directives are too severe they will have an adverse effect on the market to the point at which a few will companies will be likely to close.
“We know this because many are contacting us now” said Mr. Mana. “When taking regulated brokers as customers we don’t look at just profitability, we also look at cash balance. Most retail brokerages are not operating on their actual projected profits, but are instead operating on cash. A lot of brokers have had a lot of problems with cash, and this change will probably choke brokers so they are looking for additional value in acquisition conversion and retention. They cannot maintain the status quo of low margins” explained Mr. Mana.
Whilst Mr Mana fully appreciates that CySec, along with other MiFID jurisdiction regulatory authorities have to continue to protect clients in terms of withdrawals, and that the sales channel has been substantially reorganized in that call centers need to be tied agents and more responsibility and monitoring has been mandated, he believes that B2C brokerages need to find a way to inrease their profitability by increasing revenue or decreasing cost.
“We understood this a year ago and created tools such as Optim8 and Activ8, and also continue to major on social which is a strong conversion tool” said Mr. Mana.
“If we look at the acquisition side of the sales channel, most brokers are relying on affiliation for onboarding new clients, whereas for conversion it’s all about quality of leads in an environment in which there are people converting manually, and in retention it is about calls” – Sami Mana, General Manager, Leverate
“A major concern that has been apparent for quite some time now is that it has become very expensive to convert clients. The cost can be between $600 in some cases to $1500 in extreme cases in which the clients are higher net worth, so most brokerages are losing money on acquisition. On the conversion side they spending on employees, multiple language capabilities and different hours to cover global markets, which sometimes requires between 200 to 300 staff to manage in a call center environment and this is outmoded and expensive.”
Mr Mana concurs that considering these factors, many brokerages are looking very seriously at automation.
“What is the biggest problem for B2C brokerages?” asked Mr. Mana. The answer to this he is certain is regulation, and the methodology by which certain regulation applies to the way that brokerages can intereact with their retail clients.
“Brokerages are not allowed to say certain things to clients, and cannot use forceful sales tactics. In a regulatory circular issued by CySec, it was made clear that brokerages cannot even pay employees according to P&L, and that remuneration has to be based on a fixed salary. Obviously brokers can find ways around that because if they don’t compensate according to P&L nobody will work.”
“Another matter is that brokerages are bound by the amount of margin that is currently being used. Often, brokers have a large amount of client funds but cannot benefit from the potential volume because in most cases the trading is only using around 10% to 15% of client balances which is very low, and the bottom line is that this results in very low commissions.” – Sami Mana, General Manager, Leverate
“Social has often been heralded as the holy grail of client retention, however there is a need to leverage it through webinars and money managers to generate volume & P&L. Currently B2C brokerages are starved of new solutions because of changes from CySec and the FCA.
“What some companies are trying to do with acquisition is to develop their internal network and media. If a broker can optimize internal media and can get their CPA down to $200 rather than $600 to $1500 then that would be progress. Brokers will need to perform optimization in all those three areas in order to survive and stay successful” explained Mr Mana.
“Thus, it is important to consider that with regard to liquidity providers bearing these matters in mind when onboarding brokers, most liquidity provision these days is not focused toward EU markets. Instead many liquidity providers are concentrating their efforts on Hong Kong, South East Asia, Mainland China and other large unhindered markets. Anyone based in the European Union only will be dramatically affected.”
What should brokers do? – Go multi-product!
Mr. Mana explained what he thinks an EU broker should do bearing all of this in mind. “Diversification outside of the EU is ideal but that’s not always possible” said Mr. Mana. “Optimization is another aspect but what they can also do is expand their product range.”
“One of the things that will be a hot subject at the moment is multi-product offerings including listed derivatives as well as OTC derivatives available on one platform, building a strong liqudity base in other assets in ETFs and exchange listed derivatives and these are, although more expensive, subject to lower leverage and have longer lifetime value with higher deposits. It is effectively the same process that is happening in the US.” – Sami Mana, General Manager, Leverate
Concluding, and continuing on the subject of multi-product retail offerings, Mr Mana said “Multi-asset brokerages which operate in a similar way to that of Interactive Brokers in America would be a good direction to avoid the current regulatory difficulties. Look at France. The AMF don’t let brokerages do any advertising of OTC derivatives products.”
“There will of course be an increase in costs, due to exchange membership fees, the need for licensing on exchanges and clearing charges, however what we are witnessing is a change in the DNA of the industry from that of the days when the retail FX business first became established. At the outset, the DNA was originally based on sales people, they did not understand financial markets structure, only how to sell. This business is far from about just selling, it’s understading what trading is, what financial markets are and how they work, and the need to become more professional and understand the markets better and have better DNA on an ongoing basis.”