What brokers can expect from ESMA’s guidance on copy trading
We spoke with industry leaders to learn their first thoughts regarding the European guidance on copy trading, and what issues brokers and technology providers may encounter.
In late March, the European Securities and Markets Authority (ESMA) issued a supervisory briefing on copy trading services. If you haven’t read the document yet, you can find it here.
ESMA’s supervisory briefing comes more than ten years after the regulator published a Q&A in relation to the legal qualification of the automatic execution of trade signals and goes one step further, taking into account MiFID II requirements.
How can brokers comply with ESMA when providing copy trading services
The briefing was published in accordance with ESMA’s objective of fostering investor protection and actively promoting supervisory convergence across the European Union, thus setting out expectations of both ESMA and National Competent Authorities (NCAs) with regard to MiFID II requirements on:
• Information requirements (including on marketing communications and costs and charges)
• Product governance
• Suitability and appropriateness assessment
• Remuneration and inducement
• Qualifications of traders whose trades are being copied
The document also includes indicative questions that supervisors could ask themselves, or firms, when assessing firms’ approaches to the application of the relevant MiFID II rules.
The European top regulator and local authorities will continue monitoring the development on this topic and may therefore undertake other steps in the future to assure that copy trading is provided in a manner that is consistent with the applicable MiFID II requirements and that investment services continue being provided in the best interest of the client.
FinanceFeeds spoke with industry leaders to learn their first thoughts regarding the European guidance on copy trading, and what issues brokers and technology providers may encounter.
How can technology help brokers achieve compliance, especially at times when the regulatory landscape is changing?
For that matter, we spoke with TraderEvolution Global, a leading software development company located in Ireland that specializes in trading platform development for brokers and banks. The company provides brokers with multi-market trading software to offer stocks, ETFs, futures, options, FX, CFDs, and crypto.
Marcin Nowogórski, Business Development Manager at TraderEvolution Global, said that ESMA keeps repeating a “case-by-case” approach which likely means individual assessment and individual approaches to how certain investment services should be carried out in practice so different firms could have different needs in terms of adjusting their technology and software solutions to efficiently meet those requirements. This creates a need for additional development tailored exactly to each broker as we see it at TraderEvolution.
“In our practice, we usually develop or adjust certain functionalities upon request or in close cooperation with our clients thus specific requirements that come from brokers are carefully taken into account. ESMA indicates that in some setups investment firms may be executing some portfolio management or financial advisory services through third-party firms and external software services which makes it more difficult to control the regulatory compliance aspect. Building solutions with multiple 3rd parties brings interesting potential but also raises certain risks in terms of controlling the way how your business operates and how licensed services are delivered.
“Our experience in TraderEvolution was that numerous tasks can be handled by external, software components from specialised 3rd-parties, components which we could integrate with the main brokerage system. In many cases this is good for clients from various parts of the world who make different, sometimes region-specific choices about certain features of their brokerage setup. When it comes to core trading functions, however, with our software we support not only self-directed trading and investing but also trade recommendations and portfolio management to let our clients keep those usually licensed investment services within a single environment which is easier to control and adjust when needed.
“Another aspect highlighted by ESMA is how clients are informed about risks, benefits, and costs associated with considered financial services. It is one of those aspects that shapes some of the key requirements for the brokers’ communication with their clients and in the end for the user interface in trading applications. Ability for the broker to actively influence the look and functionality of trading applications that he uses will be critical here. It is something that a responsible platform vendor who works closely with his clients should offer via additional development and customization on an ongoing basis.”
What EU-regulated brokers think of ESMA’s guidance on copy trading
FinanceFeeds also reached out to FXOpen, a leading FX and CFD brokerage firm authorized in top jurisdictions, including Australia (regulated by ASIC), the United Kingdom (regulated by the FCA), and the European Union (regulated by CySEC).
We spoke with Natalia Zakharova, Head of Business Development at FXOpen, to get the perspective of a reputed CFD brokerage firm authorized to operate in the European Union through a license issued by CySEC.
“It was inevitable that some of the mainstream financial markets regulatory authorities in key regions of the world which have developed financial markets economies would look toward considering the status of copy trading facilities. For quite some time now, the European Securities and Markets Authority (ESMA) has been considering the method by which copy trading should be regulated, largely due to the need to provide recourse for investors who have put their faith in another trader – in many cases another retail trader – to execute trades with the best possible outcome in mind.
“Currently, copy trading is not considered portfolio management and anyone providing such a service does not need to be licensed as an asset manager, mainly because copy trading is considered an ‘execution only’ service in which no financial advice has taken place. In essence, copy trading is defined as ‘automatic execution of trading signals’.
“The recent Supervisory Briefing issued by ESMA simply reinforces some prudent guidelines that are advisory toward providers of copy trading services. It looks at the ability of copy trading providers to assess the suitability of their clients to copy trading and looks at how copy trading providers are remunerated. The important area to focus on within the briefing is that ESMA has now officially confirmed that that copy trading services are likely to either fall under portfolio management or investment advice, depending on the circumstances“, FXOpen’s Zakharova continued.
“Let’s remember that a few years ago, the end of social trading came abruptly after a period during which so many firms offered it to the extent that it was the big innovation of the time among retail trading providers. Largely, social trading disappeared due to its perceived conflict of interest between broker, trader, and investor, the investor being the individual who chose to follow another trader’s patterns via social trading platforms. These systems allowed brokers to pay commissions to social trading leaders, who would drive trading volumes by attracting followers.
“Copy trading is subject to no such possible demise, but clearly the regulators are constantly looking at how to ensure that financial services firms that provide copy trading can prove that they are not acting against their clients. This briefing, whilst just informative at this stage, is therefore the first official step toward brokers in the European Union having to register copy trading providers as asset managers or financial advisors“, she added.
To conclude, FXOpen’s Zakharova gave a few examples to remind the industry that potentially new regulatory changes might fail to have the desired effect. “Will it solve anything? Possibly, however, Neil Woodford, the famous portfolio manager whose fund collapsed a few years ago leaving many investors who had been automatically following its strategy high and dry, was a traditional portfolio manager and licensed as such. Hargreaves Lansdown, one of the largest retail financial services firms in the world, was offering a Woodford portfolio and faced a £100 million lawsuit from its customers who lost funds due to the collapse of the Woodford equity income fund. Yes, it is good to regulate such activities, but to change the entire course of how traders offer their expertise to others for no greater good would be anathema.”
