Why are FX firms not subject to consumer credit licenses? – Op Ed
Despite the terms and conditions of many FX trading contracts stating that customers could be held liable for negative balances, it is very rare for any brokers to ever go after them for it, and there is no requirement for consumer credit licensing. We examine the circumstances behind this matter which is unique to FX compared to the entire financial services industry
Thought leadership is one thing, thought co-operation is another, yet it is the latter that is probably the most important!
Speaking to several senior executives in the risk management sector of the electronic trading industry yesterday in London, a very interesting perspective, which appears to be quite commonly held, is that brokerages (and their respective liquidity providers) that operate an agency model in which orders are processed directly to a live market, do not need to hold a consumer credit license.
Why would a consumer credit license be necessary?
What has consumer credit got to do with retail FX trading may well be a question that has never been asked, because the two at first glance appear to be completely intangible, however they are actually inexorably linked, particularly when considering the consequences that a customer could potentially face if sudden market volatility, or the omission of setting a stop loss sends a retail FX trading account into a negative balance.
Currently, despite the extremely advanced nature of modern regulatory structures in major electronic trading centers such as Britain, North America, Australia, Singapore and Hong Kong, there are no stipulations that a brokerage must register itself under any consumer credit act, or license itself as a vendor of consumer credit, whether it extends what is effectively ‘credit’ to retail customers, or whether extending aggregated liquidity to retail brokerages.
What is particularly interesting in this circumstance is that it is clearly a question on the minds of many regulatory technology firms as well as risk management solutions providers whose expertise spans several continents, yet no actual event has occurred in which a reaction from a government body to any exposure to negative balances has caused brokers to have to register as a consumer credit provider.
Almost two years have elapsed since the Swiss National Bank (SNB) suddenly removed the peg on the EURCHF pair, creating a massive and unexpected surge of volatility which in some cases actually finished off entire retail brokerages due to insolvency, as they were unable to recapitalize after exposure to negative client balances.
Ultimately, the clients with smaller balances which owed brokers that weathered the storm but sustained losses due to such exposure did not by and large pursue their retail clients for negative balances, however they would have been well within their remit to be able to do so.
Enforceable or goodwill gesture?
Had they wanted to, brokerages could have settled their losses to the banks by pursuing all of their clients, because in most cases, terms and conditions between broker and client often state that it is entirely possible for a trading account, especially where leverage is involved, to dip below zero in which case the trader could end up owing the broker, thus collection of the debts would apply in the same fashion as defaults on private or commercial bank loans, or mortgage arrears, or unauthorized overdrafts on a bank account.
However, no company ever pursues their retail clients, choosing to write it off instead, which could be construed as a goodwill gesture.
An example of a reaction by a large electronic trading company to the SNB event is notable in FXCM’s adaptation of its negative balance policy in March 2015.
At that time, FXCM updated a provision in its Master Trading Agreement insofar as clients that are subject to the Negative Balance Policy who incur negative balances in excess of US $50,000 which is determined by aggregating all of the client’s negative balances across all accounts held by FXCM and any of its affiliates, incurred over a 24 hour period of time became responsible for and owe FXCM the value of the total negative balance above $50,000, regardless of market conditions.
The interesting aspect here is that subject to certain exceptions, FXCM will waive the first US $50,000 of a client’s total negative balance, proving that once again, the brokers are taking the hit, thus removing any responsibility from retail clients if they get into negative balances.
What is interesting is that this would never happen to a client of any other licensed financial institution that offers retail financial services or is a broker of financial services provided by institutional firms in any other sector whatsoever.
It is indeed food for thought, and indeed a consumer credit license on a mandatory basis would perhaps raise the responsibility threshold among retail clients, as well as protect our industry from losses due to firms conducting an act of benevolence to their own detriment in a market that will never thank them for it.