For decades now, we have watched as eager retail traders signed up for demo and live accounts with FX/CFD brokers. The main barriers to success for the retail trader were and will always be experience, investment capital, and discipline. What if one of the variables, like investment capital, could be removed? Sounds great! What could go wrong?
As major players in the Fintech arena, providing award-winning systems to the retail trading industry, we can’t help but see the huge growth in the latest industry trend. Prop Trading firms and Funded Trader Schemes now account for a large percentage of new business in the industry and there are no rumours about this trend ending anytime soon. But, who is looking out for the trader?
Two Options: Regulated and Unregulated
It would be too simple to segregate the sector into two groups but, let’s have a go. We have firms that are purely stand-alone entities offering only funded trader accounts and, on the other hand, we have existing established FX/CFD brokers, offering the option of prop trading, alongside their usual live account options.
The difference may be obvious but, under the surface there exists a huge distinction. The larger existing brokers will all have licences, many from multiple jurisdictions. On the other hand, many prop firms are currently able to open up shop with no regulation at all. On the surface, a financial regulator assesses a very important factor: is the firm holding client funds? Or not?
Concerns for the Regulators
The fact that many prop trading firms do not hold client funds and that traders only pay an “evaluation fee” or a membership fee to start, might seem like a clear distinction. However, it’s not as simple as that and there are many other factors.
Anyone who has traded professionally knows that the fund manager has a strict set of risk management rules which govern your trading. Funded trader accounts come with risk management rules as well which are typically confusing to a new trader. These may vary from firm to firm and, since the beginning of online trading, your local regulator has been receiving complaints from confused retail traders. So? Will we need a standard set of risk management parameters across the industry? Good luck with that!
Another area of concern regards the payouts for profitable traders. Any confusion or unresolved conflicts will be aimed straight back at the regulator if the prop firm can´t resolve the issue. Dealing with this type of claim will be another massive hit on the resources of any regulator, which will not be welcome.
Another area in which the current crop of seasoned FX/CFD brokers often run afoul of the regulators is sales, marketing, and incentives. Regulators are not impressed when a broker offers a client or an IB a free iPad, or a deposit bonus, or a discount on commissions, etc. when they have been told specifically not to do that. Prop trading firms offer a wide variety of incentives and many have engaged in dubious marketing schemes. Another growing concern for your local regulator.
Which Regulator Wants to Know?
Speaking of dubious marketing schemes: remember binary options?? We won´t go into a detailed history lesson here because it would simply take too long but that was one huge confusing mess for everyone, especially the regulators. Clearly the concept, and the firms participating, needed to be regulated but the debate raged on for a while: is it finance or is it gambling? Which regulator gets to handle the hot potato?
At the end of the day, most of the world took the best way out and made it illegal. But, will prop trading go the same way? (Don’t be offended. Prop trading is nothing like binary options and we know that). But which regulator will take up the mantle? Finance? Gambling? Fisheries and Agriculture?
The Beginning
Very recently, a regulator raised a yellow caution flag regarding prop trading, suggesting that the industry should be subject to MiFID. The Czech National Bank said this recently and we in the industry know that the EU, under the guidelines of ESMA, have been studying the concept and the industry as a whole.
Conclusion
It is highly likely that some form of regulation will be imposed soon. As it usually happens in this industry, it will start in Europe and spread outward as other regulators watch the experiment from afar. In the meantime, prop firms should be taking a serious look at the situation. Applying for a license in a recognised jurisdiction is only one step. To be compliant, transparent, and efficient firms must employ the latest technology in CRMs, payment systems and eKYC. Please don’t hesitate to give us a call. We are here to help.
