No more trading against your clients! European regulator cites conflict of interest, FinanceFeeds investigates

It took several years for the regulatory authorities in many jurisdictions that are populous with retail FX brokerages to address one of the longest standing taboos since the dawn of electronic trading companies that position their services toward the private individual. Seventeen years have elapsed since the establishment of Matchbook FX, which paved the way […]

trading

It took several years for the regulatory authorities in many jurisdictions that are populous with retail FX brokerages to address one of the longest standing taboos since the dawn of electronic trading companies that position their services toward the private individual.

Seventeen years have elapsed since the establishment of Matchbook FX, which paved the way for retail brokerages, however it wasn’t until the mid-2000s that the influx of B-book brokerages headed onto the market, most of which used the MetaTrader 4 platform and offered fixed spreads, whilst executing orders via a dealing room which warehoused trades – effectively giving rise to what became colloquially referred to as the ‘profit and loss model.’

Whilst the entire retail FX industry has evolved significantly over the last seven or eight years and trading platforms are now designed to be connected to liquidity providers which in turn have relationships with Tier 1 banks in order to provide aggregated liquidity and give retail traders a finely honed system which provides direct access to the world’s currency markets with pricing that reflects the live market , only now have many regulators began to take a close look at the method by which brokerages execute trades on behalf of clients.

Many brokerages which traditionally operated a ‘profit and loss’ model were unregulated, therefore creating a situation in which there was no jurisdiction, whilst those in regulated markets operated according to best execution practices.

This subject has now become a priority for the European Securities and Markets Authority (ESMA) which has issued a very direct statement which reads “Where a firm is adopting a dealing model under which the profit made by the firm is dependent upon the clients of the firm making losses, such that the execution of relevant transactions is inseparable from a material conflict of interest between the firm and its clients, NCAs should consider whether the conflicts of interest arising from such a model can be managed, and, as a consequence, whether such a business model can comply with firm’s obligation to act honestly, fairly and professionally in accordance with the best interests of its clients (Article 19(1) of MiFID), and to take all reasonable steps to avoid conflicts of interest.”

mushegh
Mushegh Tovmasyan

“For example, a firm offering CFDs or other speculative products acting as the counterparty to a retail client’s trade without any hedging arrangements in place has no incentive to execute orders in the best interest of the client, because if the client “wins”, the firm “loses.” Such a conflict of interest in all likelihood cannot be managed and should therefore be avoided, by not adopting such a business model” states ESMA.

This may well signal the end of the profit and loss model among all brokerages in Europe, and therefore it is important to gain perspective from liquidity providers and prime brokerage firms as to how this impacts the industry. Many brokers that were asked for their opinion on this matter declined to comment, however the perspective from those who did is very interesting indeed.

Mushegh Tovmasyan, CEO of Divisa Capital explained to FinanceFeeds today: “ESMA is targeting three potential offenders, as follows:

(1) STP firms that use their offshore group company as a counterparty to effectively skirt regulatory oversight and capital requirements;

(2) Companies who STP flow to a B book Liquidity Provider and benefit from a profit share; and

(3) Companies who do not have any hedging relationships at all.

Mr. Tovmasyan explains further that “I disagree that ESMA are putting a blanket ban on B booking. Instead, there is a growing effort to make sure that B booking is done within the providers’ financial means and that firms seeking to engage in risk management do so in a transparent manner that does not cause conflict with clients or regulators.”

“Brokers fall foul with the regulators when they claim to be STP but all volume goes to a non-regulated B book shop, and conflicts of interest with clients occur when they advertise STP, interbank, ECN execution when in fact all trades are going to another B book shop, usually an unregulated one” said Mr. Tovmasyan.

Mr Tovmasyan added that “this should not come as a surprise to the more risk prone B book shops out there, who have known for a while that they need to diversify their risk by securing access to real liquidity in the interbank market to cope with changing market conditions.”

Yiannis Gerousis, Head of Dealing at FXPRIMUS explained to FinanceFeeds “Market making firms who deal on account should make all efforts to act as a systematic internalizers by matching clients positions with each other, and thus profit from spread with no hedging cost. Trying to be on the other side of the trade and waiting for clients to lose so they can profit from losses might lead to conflict of interest which should be Indeed, whilst the b-book model is likely to continue to be the execution model of choice across many retail brokerages, it is clear that the regulators are accepting to this – of course it has certain risk management and execution speed benefits, however maintaining a facility to provide true market pricing is becoming an increasing focus of the regulatory authorities, as is ensuring that brokers do not view client deposits as their profit.

Image courtesy of Banco Carregosa

Read this next

Retail FX

Banxso announces 8.7% interest rate on deposits in South Africa

“With Banxso, they can enjoy the benefits of both worlds – earning competitive interest and having the freedom to trade, all within the same platform.”

Industry News

FINRA to publish transaction details in U.S. Treasury securities

“Consistent with our longstanding practice, FINRA is introducing greater transparency in a calibrated and careful manner, benefiting liquidity and resilience in this critical market while also mitigating potential information leakage concerns.”

Institutional FX

OpenYield launches “cheap and easy” fixed income trading for brokers

“We’re on a mission to make bonds cheap and easy to trade, and are excited about the opportunity to build generational capital markets infrastructure.”

Digital Assets

Sumsub and Mercuryo publish a guide for VASPs: “Mastering Travel Rule Compliance”

“At Sumsub, we’ve concentrated our efforts on filling the gap in understanding the complexity of Travel Rule regulation and helping organizations find the best solution to stay safe and compliant while minimizing costs and avoiding potential risks of non-compliance. This guide we created with Mercuryo, our trusted partner, is the ultimate navigation tool all VASPs can consult.”

Digital Assets

Bitget Wallet Leads with Record Swap Volume & New Crypto Innovations

This week, Bitget Wallet achieved a milestone by surpassing Metamask with a record 388,757 Swap order transactions, securing the global lead. The significant 7-day trading volume, almost 68,000 more than its rival, underscores its liquidity and user trust. This robust activity signals Bitget Wallet’s prominent role and reliability in the dynamic crypto market.

Digital Assets

Embarking on a Digital Currency Journey

Imagine you’ve stumbled upon a treasure map, leading you to untold riches hidden in the vastness of the internet. Instead of gold coins and jewel-encrusted goblets, this treasure comes in the form of digital currencies, the modern-day loot coveted by many.

Reviews

Traders Union Experts Share The Trading Analyst Review For 2024

Navigating options trading in rapidly shifting markets poses a considerable challenge. This is where options trading alert services become invaluable. They aid traders in keeping abreast of evolving opportunities and market trends. In this assessment, Traders Union experts scrutinize The Trading Analyst alert service to ascertain its efficacy. 

Digital Assets

BlockDAG’s Presale Achieves $9.9M: Aiming For A 5000-Fold ROI As Cardano’s Price Rises And Fantom Launches Sonic

Explore Cardano’s surge, Sonic’s efficiency, and why BlockDAG’s growth makes it the top crypto choice. A deep dive into the future of blockchain investments.

Digital Assets

US, UK probe $20 billion Tether transfers tied to Russian exchange.

U.S. and UK authorities are investigating the movement of $20 billion in the USD-pegged stablecoin tether (USDT) through Moscow-based exchange Garantex.

<