Regulated brokers operating warehouse P&L model via the back door

Regulated brokers operating warehouse P&L model via the back door by onboarding clients offshore

Brokerages with genuine regulatory licenses and substantial low-deposit business in non-regulated regions are using genuine regulate entities to promote their status, yet are onboarding most of their business via unregulated offshore divisions, and operating on a warehouse basis often with no liquidity feed. We take a look at how this works

This week, FinanceFeeds conducted a detailed investigation into the practices of brokerages which purport to be regulated yet are not, and how the practice in some cases extends to the establishment of retail brokerages in mainstream, regulated jurisdictions which share common ownership with nefarious offshore companies which engage in fraudulent activities, just the names differ.

Indeed a matter worthy of consideration is how regulatory authorities in specific regions that are synonymous with the FX industry, with their reputation for high quality business, have the burden of companies operating unregulated offshore business from different regions, outside the regulatory oversight of specific national authorities.

A case in point here is that certain brokerages which are at the lower end of the deposit spectrum, with the majority of their business not being in the domestic market, are operating two different business models within the same organization, one which fits the regulatory criteria of the entity based in the regulated jurisdiction and the other in the unregulated entity.

In short, many smaller brokerages are not just operating from two different regions, but are employing a different trading environment for each.

The first example that we investiagated was HotForex, which has a relatively large presence in the Asia Pacific region, as well as other jurisdictions outside Europe such as Russia and the Commonwealth of Independent States, yet it also has its main entity in Cyprus, with CySec licensing yet only a small percentage of its business is channeled through Cyprus, most being offshore, thus gaining the kudos of being CySec regulated, yet conducting the lion’s share of business offshore with no regulation.

The company is registered in St Vincent and the Grenadines, a region in which FX is NOT a regulated financial instrument, and has not been since the St Vincent and the Grenadines financial regulator stated clearly in an announcement in 2014 that

The Financial Services Authority wishes to advise that it does not ‘Regulate, Monitor or Supervise” International Business Companies (IBCs) which engage in FOREX Trading or Brokerage. Statements of this nature are a misrepresentation of the Authority’s supervisory powers with respect to IBCs.

“The Authority does not approve or sanction the business activities of IBCs upon their incorporation. The extent of supervision of IBCs goes no further than to ensure that IBCs comply with their obligations under the International Business Companies Act. The Authority also does not license the activity of FOREX Trading or Brokerage and any IBC purporting to be licensed by the Authority to conduct this business activity is making a false statement” said the statement from the regulator.

An investigation into the structure of HotForex and its CySec regulated sister company HF Markets uncovered an interesting dynamic that is not exclusive to this particular company, but was brought to light by an internal source following our research.

A call to HotForex support today confirmed that the company operates separate business models in different regions, the support representative having said

“Our CySec division is only for European clients. Non european clients are catered for by our St Vincent and the Grenadines entity. Many non European clients do not fall under the European regulation, such as Russia and Israel. Many other brokers just accept any client from anywhere under their CySec license but this is wrong. All the clients come to HotForex, we have them under different entities but are all serviced by us”

The representative insisted that the company was regulated in St Vincent and the Grenadines, however this cannot be the case as there is no such regulation in that jurisdiction for FX firms. The telephone number from which the call was received during which the HotForex representative explained this was from the company’s Cyprus head office.

A source close to the matter further explained “Many companies, including HotForex, although they will say they are CySec regulated, 95% of their clients come under the offshore license. Why is this? It is because this is where b book clients go, and when audited by the regulator, this does not show up therefore it looks like there is no risk of breaking the regulator’s rules.”

Russia-focused, Cyprus based brokerage EXNESS is another case in point. The company enjoys significant presence on Limassol’s exquisite new marina complex, in a very prominent building within which the abundance of staff is notable by its absence.

The company has a CySec license, however is also registered in St Vincent and the Grenadines, and according to research by FinanceFeeds, the vast majority of its business is from Asia (mostly mainland China), Russia and the Commonwealth of Independent States.

A discussion with EXNESS customer support revealed that EXNESS will allow clients to register for accounts with the CySec entity in Cyprus, or with the unregulated St Vincent & The Grenadines entity.

When asked whether the company is regulated in St Vincent and the Grenadines, we were asked to wait for a while whilst the representative checked. After a few minutes, the representative confirmed “EXNESS is a Cyprus regulated company, regulated by CySec, whereas EXNESS VC (St Vincent and the Grenadines) is an international business company.”

This representative is indeed absolutely correct, however clearly states that one entity of the firm is regulated by CySec, and the other is not regulated by anyone at all.

EXNESS channels the vast majority of its business through the division of the firm in St Vincent and the Grenadines, offering massive leverage of up to 1:2000, the company having intentionally moved away from New Zealand when the Financial Markets Authority was formed, clamping down on bucketeering and highly leveraged margin FX that had been prevalent in the pre-regulation era.

The firm canceled its New Zealand registration and opted for St Vincent and the Grenadines as a region to continue its business, which was largely from China – as it still is today. Whilst volume figures in general must not be considered accurate, EXNESS notes that its revenues from China form a substantial proportion of the company’s business.

Whilst the firm was honest in explaining that it does not have regulation in St Vincent and the Grenadines, yet does in Cyprus, the majority of its clients are being serviced by the unregulated entity. We asked EXNESS for a division of how many clients are serviced by each entity, the company declining to provide such information.

Once again, CySec allows the firm to continue to rest on the laurels of a CySec license, yet use an unregulated jurisdiction from which to service most of its clients on a P&L warehouse basis.

These of course are not the only two firms that engage in this practice, however they are large names in certain parts of the world. EXNESS for example, is a major player in China, FinanceFeeds can confirm that this is the case due to our findings during a large scale investigation into introducing brokers in Tier 2 development towns across China.

On the broker supplier lists of some firms that are executing up to 90,000 lots per month in mainland China, EXNESS nestles just a few rungs below the top level firms of North America including FXCM and GAIN Capital for IB penetration across China’s all important new and rapidly expanding towns with vast money managers and IB offices that are larger than most brokerages, yet the end user has absolutely no recourse should something go awry, whereas they do in the case of the top quality brokerages from North America and Cyprus that are favored by most Chinese IBs.

FinanceFeeds then contacted CySec for a comment on this matter, the regulator having declined to comment, however FinanceFeeds recognizes that CySec is a civil regulatory authority that has jurisdiction over its own territory and does not have any legal authority over non-European entities, however licenses issued to firms that have other branches in offshore jurisdictions from which they purport to be regulated but actually are not, and are operating the majority of their business from the latter entity on a warehouse profit/loss basis, perhaps are not compatible with mainstream jurisdictions.

CySec does have the power to cancel CySec licenses, however there has never been a cancellation of a license of a CySec regulated firm as a result of its activities outside Cyprus, which may well be a good avenue to follow in future, following in the footsteps of Australia and the United States, both nations in which the regulators take action against firms in their jurisdiction for the less than provident activities of overseas subsidies on a regular basis.

Until genuine cross-border rulings exist, it may be prudent for regulators in bona fide jurisdictions to insist on a separation of entities under their rules from the divisions of the companies offshore with no regulation, or to not grant licenses to offshoots of offshore firms.


#b book, #fx, #p&l model, #regulated forex brokers, #regulation

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