Regulated firms onboarding clients via offshore entities: “No problem as long as clients informed” says broker

As there is absolutely no law against brokers having an offshore entity as well as a regulated one, the onus should be on brokers to explain to customers the benefits and drawbacks of both, and provide all information to allow clients to make an informed decision on what leverage, terms and recourse they have

Over recent years, FinanceFeeds has looked closely at the practice which is relatively prevalent in certain regions, of onboarding clients via a separate division of a brokerage based in an offshore jurisdiction such as St Vincent and the Grenadines, yet using a MiFID II compliant, Europe-based main entity to display that the broker is bona fide and regulated by a major financial markets competent authority in a first world capital markets center.

Opinions vary on whether the leverage restrictions on spot FX and CFDs which have been a priority of regulators in the UK, Australia and across Europe over recent years are good or bad for business, some of the more reputable companies understanding that this is a stabilization method which should be adhered to, and that traders should place more margin capital in their accounts and be subjected to less risk, and others choosing to find ways around it.

The European Securities and Markets Authority (ESMA) was one of the first regulators to implement a leverage restriction in markets outside North America and Japan, and in doing so in 2018, was met with mixed perspectives and actions from brokers.

Japanese regulatory authorities had restricted leverage to 1:25 some eight years ago. Japan, being the largest retail FX market in the world and home to over 35% of global retail FX volumes, all traded by domestic market clients through domestic market companies, was a great model for the implementation of strict leverage restrictions, as volumes actually rose even further following the 1:25 leverage ruling.

Despite this stability enhancing dynamic demonstrated by Japanese trading after the leverage restrictions were implemented, this was not carried over to some other markets and in Cyprus in particular, many firms use their main entity to demonstrate Europe-wide compliance and MiFID II execution adherence, yet use offshore entities to provide trading terms that are not allowed by ESMA.

Last week, FinanceFeeds highlighted a case in which a retail customer had not been informed by a broker that his account was being operated with extremely high leverage and that he had been onboarded by what he had thought was an ESMA-compliant Cyprus based brokerage’s main entity, when actually the broker had onboarded his account via a St Vincent and the Grenadines sister entity and was providing extremely high leverage and a bonus, both of which are not allowed under ESMA rules. As a result, a tale of woe ensued.

Today, we spoke to Natalia Zakharova, Business Development Manager at FXOpen, a large brokerage with regulatory licenses in several of the large, recognized financial markets centers, in order to ascertain an inside view on this matter.

“As a broker holding both CySec license and having an offshore entity, we do not see any issue with a broker routing clients to the offshore entity.”

“The main factor here is for the client to be able to make an informed choice. Obviously provided that the broker clearly states the risks of trading with higher leverage and mentions that the entity is not regulated and outlines the benefits of trading with a regulated broker” said Ms Zakharova.

“We don’t see why a broker cannot have several entities, regulated and unregulated, as long as they are run separately and business practices are honest” she concluded.

Absolutely right. It is not so much the structuring of brokerages with  offshore entities as well as regulated ones, but more the practice of not informing clients, or offering clients a choice as to the terms under which they would like their accounts operated that is the issue here.

This applies not only to retail direct clients but also to partner networks, especially in the APAC region. Indeed operating, for example an Australian firm with ASIC regulation only is a very sustainable route to a long term business, however in the aftermath of recent regulatory rulings such as that by ASIC which has prevented FX firms from onboarding non-Australian clients, having a potentially decimating effect on those which have relied heavily on Chinese IB networks, brokerages have been faced with a choice.

The choice is quite simple: Either to take the good and solid revenues earned from having garnered a very well organized Asia Pacific-based partner network, and reinvest it into developing trading systems and product ranges that would take a retail broker into new and popular audiences, and join the realms of the new, app-based retail trading platforms which allow bank accounts, mortgages and trading on one app, or to rival the challenger banks such as Revolut.

The amount of high ticket venture capital that is being invested in these new entities is enough of a measure of the confidence that the financial world has in them as the future structure of banking, retail finance and technology and their own system and customer base means that their intellectual property is their own when it comes to valuation time for public listing.

With MiFID II in Europe stipulating that all trade reporting must be correct and all infrastructure must fit best execution practices for regulated marketplaces, ETFs or market makers, leverage restrictions in place, and with Australia about to follow suit with the added aspect of the US-style ruling on no cross border client bases, firms can either invest in their future and aim toward a domestic, good quality audience which requires multi-asset trading and a modern experience, or throw in the towel and go offshore.

In Cyprus, home to over 150 retail FX brokerages, ESMA’s ruling was not as welcome in many cases, as firms began to onboard their clients via offshore entities under the same company in regions such as the British Virgin Islands or St Vincent and the Grenadines, those being regions with no regulation at all, and no resrictions on leverage, and then continue to hold a CySec license in Cyprus and use it as a marketing and client onboarding tool whilst not putting any clients through it.

FinanceFeeds investigated this in detail some years ago, as many firms were conducting this practice well before the leverage restrictions were enforced, making it even easier to subvert the rules once they were enforced.

As CySec has no jurisdiction outside Cyprus, and firms are allowed to operate sister companies with offshore licenses and onboard clients to those entities with all kinds of terms that would not be permissible under ESMA, CySec is powerless to prevent any firm from offering extremely high leverage, bonuses and other non-compliant trading terms via offshore entities and then tell clients that they’re ESMA regulated.

Neither ESMA nor CySec stipulate that if a broker holds a CySec license, it cannot hold any other offshore offices, nor does it stipulate that brokers must only onboard clients to a CySec entity.

Thus, as Ms Zakharova rightly says, the onus is on the broker to inform clients of their options, and provide a choice in which clients can make informed decisions as to whether they wish to be under the fully regulated entities of a brokerage, meaning low leverage, less risk and longer term security, or under the unregulated entities of a brokerage, meaning limitless leverage, ‘exciting’ trading terms but no recourse should something go wrong.

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