2018 should be a year of quality and sustainability. Here is why it is important to avoid the seemingly cheap and easy jurisdictions and to go the full way and be part of the high quality establishment.
Today represents the monumental implementation of a very comprehensive infrastructural directive for electronic trading companies whose commercial base is in the European Union and Britain, that being the much discussed yet scantly understood MiFID II.
FX brokerages across the world will, from today, experience a completely different operational method, largely due to their interaction with European firms, and will be subject to specific trade reporting and transparency rules, as well as a standardization in terms of the structure of each type of company.
The MiFID II directive, although the subject of a lengthy development period, has come about as a result of the increasing focus on OTC derivatives and the transparency of their business by regulatory officials in central government, largely due to the vast differences between certain regions and others within the European Union’s governmental remit.
On this basis, it is now an appropriate time to assess which regions and FX, electronic trading and OTC derivatives centers are the most desirable for establishing and maintaining a sustainable brokerage business for the year ahead, and to examine the reasons for avoiding certain regions and for choosing the best.
Within the European Union, Cyprus has for the past eight years, been very much the destination of choice, largely because of the kudos that can be projected to clients in non-European regions globally, instilling the placebo-like sense of security that they are able to invest their own, and in some cases their clients funds in a firm that is aligned with European regulations, and has commonality with Britain’s Financial Conduct Authority (FCA) via the ‘passporting’ system yet for the large part, many firms operating in Cyprus, the business methodology differs tremendously from the corporate giants of the world’s largest and most respected financial center, London.
London’s 30-year established, often publicly listed multi-asset firms with their own very advanced proprietary trading systems and senior management whose extensive knowledge and understanding of technology, financial services and global business conduct sets a standard in refinement and sophistication, along with their vast market capitalization and largely domestic client bases represent the antithesis of Cyprus’ small, easy-come-easy-go MetaTrader 4 based white label brokerages which have no European clients at all and are operated in the most part by people who have never even set foot inside a large institution, let alone completed senior executive positions within any of them.
Whilst at the beginning, an end-to-end, easily set up ready-to-go brokerage with albeit very scant European regulation was a popular option, its lack of substance is now beginning to be demonstrated.
Retail customers worldwide are widely aware these days that a small white label brokerage with clients in South East Asia and Africa is not a proposition, and therefore will eschew working with them in favor of brokerages in London or Sydney.
In many cases, this is justifiable, and indeed these days so many companies and individuals that got themselves too involved with the Cyprus based entities whose owners and commercial origin does not hale from Europe are now finding themselves inexorably entwined in the crime-infested and completely bogus ICO (initial coin offering) sector which bears absolutely no relation whatsoever to financial derivatives trading, and is essentially the rebirth of the widely detested binary options fraternity that has done so much damage over the past few years.
Thus, concurrent with much research conducted by FinanceFeeds, important potential strategic partners with large client bases will largely think twice before engaging with a CySec regulated company, as the transient nature of the business there, added to the lack of regulatory jurisdiction over the real operations of many firms (many are not from Europe and actually onboard all their clients offshore whilst providing completely non compliant trading terms) as well as the marketing and lead-buying ethos rather than financial markets background tends to deter many.
Hence, the preference is for Australian and British OTC derivatives firms for those with sustainable business and large client bases, in pretty much every region of the world.
A very good measure of this quality is not only a case of asking a few large Chinese IBs what they look for when placing tens of millions of dollars worth of customer business with an overseas brokerage, all of whom will first say “a London base and FCA license“, but also to check how many dubious companies exist which offer to provide consultancy and legal services in establishing a brokerage.
There are a plethora of firms, often with extremely dubious backgrounds, which will establish a brokerage and maintain it on behalf of those wishing to be licensed and up and running quickly. Often, the regions covered are Vanuatu, British Virgin Islands, Marshall Islands, St Vincent & The Grenadines and, yes, Cyprus.
A quick due diligence check will reveal that most of these firms tend to represent gaming, adult entertainment, binary options and ICO schemes, hence they are not credible, neither are the regions which they promote registration of FX firms, however many are based in Cyprus and some in Israel.
When researching how many of these operate the same service on behalf of London-based FCA license applicants, none whatsoever would fall into that category.
This is because brokerages in London, or wishing to establish in London, have their own corporate legal departments and compliance officers, their own R&D divisions and a senior management team that is able to navigate the proper way to do business.
Simply, these are experienced entities whose rationale is to go for the long term and do quality business, rather than pay a pseudo-lawyer a fixed fee to get a ready-to-go package from which to spend two years stealing customer money before running away.
Indeed, we checked, and some firms will actually provide a CySec license, as well as a Vanuatu company registration and a bank account in Georgia, thus actually paving the way for their own clients to break the law and filter off customers to non-regulated jurisdictions whilst masquerading as MiFID II compliant brokerages.
One particular lawyer told us “You need facilities in an offshore region. The CySec license is just for marketing, not really for your business activity.”
That sentence in itself is enough to ring the alarm bell. Even the banks are now aware of this. FinanceFeeds spoke to a prime brokerage division of a large bank in London this week. During that conversation, a senior executive explained “We are aware of this and therefore we are very careful about who to extend services to. We know that most firms are bringing clients in via the backdoor and giving them vast leverage, which is against our terms, hence we fully realize that CySec is just window dressing and used by sales and marketing, whereas the client activity is often conducted via the back door.”
This means that most of the firms are not sending their orders to the bank, either, especially as those who onboard offshore are contravening the leverage and trading terms requirements stipulated by their Prime Brokerage agreement.
Thus, Cyprus government is also concerned. Whilst CySec itself continues to lack direction, the government does not, and realizes that very soon this situation will do irreparable damage to Cyprus reputation as a good and safe region for overseas investment, hence the government is looking to outlaw all ICO business, binary options and the small b-book profit-and-loss brokerages and replace them with funds and family offices.
Meanwhile, the FCA remains the regulatory license of choice, and rightly so.
For those wishing to do things properly, this is a very good proposition. The capital adequacy requirement is the same as that required in Cyprus, this being 125000 Euros for an agency license, and 730000 Euros for a market making license, however the cost of establishment is not as harsh as perceived.
In total, $50,000 should gain the license and complete the bureaucracy, then there is the minimum capital requirement to satisfy, and an office to rent.
Indeed, the UK’s FX industry is not only completely London-centric, but is actually Square Mile and Canary Wharf-centric.
Considering the cost of rent, in some of the more prestigious streets in central London, rent averages £85 to £100 per square foot, making a 4,000 square foot office (about average for a medium sized FX firm) cost anything upwards of £340,000 per month.
This is at the very upper end of office rental when compared with all other world cities, including Hong Kong and Singapore, the difference is that in Hong Kong and Singapore, the internet works properly.
Good broadband is the lifeblood of the FX industry
London languishes in 26th place when it comes to broadband speed when compared with other European capitals including Dublin (!) and Berlin, which is really quite remarkable when considering that London is highly technologically advanced and has ultra modern infrastructure compared with creaking mainland Europe.
Aside from the slow broadband speed, which at best can create difficulties connecting to trading infrastructure and at worst assymetrical slippage and non-fills of orders if the retail broker is a white label partner and is relying on broadband for connectivity as white label partners and smaller MetaTrader 4 brokerages rarely have dedicated collocation connectivity on Equinix LD4, instead relying on their internet connection to connect to their customers and to their white label provider with whom the connection to the trading servers exists, there is another problem.
This problem is that when firms move into their premises, it has become quite commonplace that the broadband internet has not been connected.
Bureaucracy is one of the major impeding factors.
Broadband providers are often unable to quickly gain access to a building in London and establish new connections because often the actual connection needs permission from a landlord, and landlords of London offices are often vast commercial real estate enterprises with large processing departments for each function.
Despite this, the way that firms in London are structured is substantially superior to anywhere else in Europe, and cannot even be compared.
This ranges from their commercial approach to the market, to their trading systems, and their very domestic market-orientated customer base which is the absolute advertisement of business acumen, which stands them in good stead for approaching other markets as a quality entity.
London based firms have immediate relationships and alignment with prime of prime brokerages, non-bank market makers, Tier 1 banks and all of the very top level entities that lead this business forward. Not a gaming site lead recycler in sight. FinanceFeeds spends its time inside the very components of this ecosystem, and it is very apparent that the relationship exists between London’s Tier 1 institutions and the FX industry, yet there is no relationship of this type between institutions and offshore firms, or marketing-led entities with CySec licenses.
Last year GAIN Capital CEO Glenn Stevens made this point very clear indeed.
Customers are “literally able to open an account as Kermit the Frog and Mickey Mouse” with some firms, he said publicly.
There are 90 firms on the Financial Conduct Authority’s register with permission to provide contract for difference or forex-trading services in London, of which 54 are passported in from Cyprus and so registered with rather than regulated by the FCA. A further 19 are passported in from other locations.
Mr Stevens called on the FCA to “tighten” its stance on passported firms, adding: “On the one hand having competition is good. But having competition that plays by different rules isn’t good. Too many of these companies operate kind of dodgy.”
“I have even heard of people registering who were able to open and register accounts as Mickey Mouse and Kermit the Frog. Some of these firms’ version of KYC — know your customer — is such a light touch that they are letting customers go right through.
“That tells me they are not following the same rules that we are, checking customers’ source of funds and doing the sorts of suitability stuff the FCA wants.”
He added: “It bothers me that there’s this backdoor Cypriot thing. It can be Gibraltar, it can be any number of locations. I know why they put this passporting thing in place because it was well intentioned — to make a more-standardised regulatory regime — but not if everybody applies it differently.”
The FCA is well aware of this, as is the European parliament, and indeed it is very likely that very important changes will be made in order to protect the standing of London’s firms and the reputation of the British regulator, as there is no way that the FCA, nor any firms holding its license, want their names damaged by firms from Africa or the Middle East with CySec licenses whilst operating outside Europe under a completely conflicting business model with that of London.
It is a myth that it is cheaper and easier to set up a brokerage in an offshore region or Cyprus. Cyprus is subject to the same stipulations in terms of regulatory capital and operating costs, regulatory reporting costs and responsibilities as London.
Thus, our recommendation is that brokerages with $5 million in start up capital or existing operating capital should be looking toward London, and those with $20 million upwards toward the United States, as an NFA license is now absolutely desirable.
Australia is another very high quality region, and has the advantage of being a very well organized financial and technology center which has deep relationships with important APAC countries, however the Australian Securities and Investments Commission (ASIC) for some years has been very reluctant to issue new derivatives trading licenses to OTC firms, and also the Australian mainstays have their roots in London – CMC Markets is one of the largest firms in Australia.
2018 should be a year of focusing on quality. Quality of service, of infrastructure and of business conduct. Hence, the way forward is to stick to the very best regions which host the leaders of the industry, and invest time and effort in being part of that, and to distance from the quick-buck schemes elsewhere.
A global audience is best garnered from the best vantage point. QED.