“Regulation is friction and does not really benefit anyone” – We investigate how CySec firms will continue to process business offshore post MiFID II

In the advent of the pan-European MiFID II directive, which is scheduled to be implemented by the European Securities and Markets Authority (ESMA) in January 2018, there is much for FX brokerages to consider, both from a trading infrastructure perspective and with regard to regulatory reporting and post-trade publication.

Yesterday morning, senior executives of post-trade execution, operation, processing and reporting company Point Nine held an official briefing with regard to the post-trade reporting requirements that will need to be carried out by all financial derivatives firms once the new methodology is fully established across the European Union.

Pavlos Christoforou, co-founder and Director of Point Nine addressed delegates which ranged from lawyers to management consultancies, brokerages and compliance specialists to institutional hedge funds and liquidity providers with regard to how the regulatory responsibilities will impact the electronic trading business, with FinanceFeeds having raised a very valid and important matter – that being the onboarding of the majority of clients by CySec regulated firms to offshore entities within which they can circumvent all regulatory infrastructure and trading requirements, and then show the European regulators the very few clients that have been onboarded via the CySec regulated entity should a compliance inspection take place.

Furthermore, firms reporting their trades would be able to report the information of a handful of trades by a handful of retail clients that fall under the CySec regulated entities and then do whatever they like with the vast majority of their business which is held in a separate entity offshore.

“I’ll focus on the actual processes and what it means to our clients” explained Mr. Christoforou.

“What I would like to say is that regulation is friction and does not really benefit anyone as most of our clients already have this procedure in place” he continued.

“Our approach in Point Nine is that since we are going to be spending this time and resource on regulatory information and spend, then we should get something out of it. So far, our expertise is mostly coming from the client side, as we have a broad base of clients at this point and very high volumes. We crossed $1 billion of trades reported a few months ago” he said.

“In terms of best execution, collecting data is very important, and it is important to distinguish whether there is data to be extracted.

“For example, if you buy a stock in Germany, the German exchanges have committed to extend the reporting to the EU regulator, but if you buy stock that is listed on the New York Stock Exhange, the reporting is not relevant because that venue and the trade conducted on it is outside the jurisdiction” – Pavlos Christoforou, Point Nine.

“Useful to provide broad categories where you fit. We have big ticket clients with private equity and investing in real estate or they are makign forwards or interest rate swap to make their position. That type of entity is easy to handle, as it is an investment firm that trades a few trades.

Then we have the high volume brokerage business. It appears to us that most brokers would be systematic internalizers. There is not much guidance from the regulator, and there were lots of questions asked and lots of direction is given by the regulator at the last moment.

“Our guess is that most are systematic internalizers” said Mr. Christoforou.

MiFID II determines systematic internalizers as market makers which deal on their own account and act as counterparty to all trades.

“As far as trying to understand the terminology from the regulatory point of view is concerned, they want price transparency and the idea is to get the information they need from firms like Goldman Sachs with their own balance sheets, which are selling bonds from within their own balance sheets. Institutions of that size know that a few hours later they will get it sold so they can take the risk. This is how the regulator will try to gain transparency on OTC prices” – Pavlos Christoforou, Point Nine.

“In terms of procss we are in discussions with two Approved publication arrangement (APAs), TRAX and Deutsche Boerse” explained Mr Christoforou. “We can gain synergies there to gain a cost effective solution on what’s needed.”

Trades that are eligible for reporting – or not!

Mr. Christoforou raised a very imoportant matter in that the regulators within European jurisidictions are strict with underreporting but have never said anything about overreporting, therefore firms have generally kept their records simple and reported everything. This, according to Mr Christoforou has led to an unexpected adverse matter in that the repositories have complained that the firms have been ‘spamming’ the regulators and will begin to accrue equally substantial fines for overreporting as they would do for underreporting.

The important matter here is that regulatory jurisdiction of reporting entity is very specific. If a trade is placed on the New York Stock Exchange, it falls outside the reporting requirements under MiFID II, as the transaction has occurred outside of the European Union.

Whilst that in itself may not be such a matter of importance, it heralds a potential problem for Cyprus’ FX industry.

FinanceFeeds is aware of several instances in which retail FX and binary options firms in Cyprus have a website which has a .com domain name and a separate one with a .com.cy domain name, which is not their main site and are onboarding clients to a P&L model brokerage offshore.

Via the .com domain, they onboard customers to offshore entities in regions such as St Vincent and the Grenadines or Belize, and then only hold a few self-directed clients which are maintained via the .com.cy site and are registered via the CySec entity of the same company.

Such firms operate ‘skeleton’ offices in Cyprus with a few staff, and then use the MiFID compliant CySec regulated veneer to gain credibility, whilst sticking firmly to the rules for the handful of clients on their CySec regulated entity’s books, thus a compliance inspection ensures everything checks out, then runs the majority of the high-leverage (in some cases up to 1:2000!) bonus-orientated high loss business via an unregulated offshore entity that falls outside of CySec’s jurisdiction.

During yesterday’s meeting, FinanceFeeds Managing Editor Maria Nikolova raised this point.

Addressing the panel, Ms Nikolova asked “If I am a CySec regulated broker, and I have a CIF license, but technically only five or six customers in Cyprus and most of my order flow is going through offshore entities, how will the new framework apply to such reporting or avoidance of reporting? We have approached CySec chair Demetra Kalogerou about this and no answer has been forthcoming.”

Mr. Christoforou said “The answer is that I do not know. As we have discussed with lawyers, there is not yet too much clarity on this detail.”

Andreas Roussos, Partner at Point Nine elaborated further: “Unregulated business exists everywhere with or without MiFID directive. MiFID only applies to registered entities in Europe, therefore it will never touch any entity of any firm that is located outside the European Union and is onboarding clients in Vanuatu or Belize. The global regulators are clamping down on them, but there are for example five people working within the regulators trying to clamp down on them, and then another five people working in unregulated firms, attempting to find the loopholes” he said.

“The only clear aspect that is useful in terms of stemming overseas unregulated business is that under MiFID, regulated firms are not allowed to use liquidity providers that are unregulated and in unregulated jurisdictions, however essentially it will take years for these frameworks to change the market” he said.

That leads me onto another question” said Ms Nikolova. “You offer this highly comprehensive solution for companies to report their trades in detail in accordance with the new MiFID regulations, which is very useful. Would you consider setting up a solution for regulators to ensure compliance with the new MiFID regulations, because it is clear that CySec needs one.”

“We have the technology for that” said Mr. Christoforou. “We would love to work with CySec on that but they do not have the same relationship with us as companies do and my personal view is that they prefer not to work with outside parties.

Thus, whilst transparency of price quality, execution and counterparty clearing is certainly paramount among MiFID II, the anomaly still remains in which the regulation only strengthens the format for brokers that are under its remit in Europe. Offshore firms, and more alarmingly, offshore branches of regulated firms in Cyprus and other EU regions are still free to offer high leverage products with no counterparty and large bonuses that do not fit the remit laid out by regulated jurisdictions.