Regular readers know that the increasingly blurred lines
between retail and institutional FX markets have bothered me for years.
Technology is a great enabler but in this case I am not sure it has been
anything other than detrimental to the market structure – a lot more trades are
being put through (for low notional value) which is increasing the ‘white
noise’ and there are clear reputational issues around the retail business.
I tend to agree with those who express scepticism over the
statistic that only 20-25% of retail traders make money – it’s probably a lot
less! Something that may boost that statistic is the number of former traders –
especially from the banking industry – moving into private trading.
Some really struggle with the lack of flow information but
given how the machines have handled that over the past decade or so this is a
relative few, generally speaking most bank traders nowadays are used to dealing
without such information. The bigger problem, speaking to people who have taken
this path, actually seems to be the isolation – it’s all very well
understanding the market but we perhaps underestimate the value of having
someone to bounce ideas off?
Away from the stats surrounding the success rate, the bigger
problem remains reputational – just look at the controversy stirred up by the
FXCM/Effex Capital issue. The harsh fact of life is that there is systematic
abuse of customers by some retail-orientated brokers (although it is important
to discern the genuine complaints from those by traders who have lost money and
are seeking a scapegoat).
The past decade has seen a gradual push back against shoddy
practices and, in some cases, criminal activity, as authorities have tightened
rules and oversight on this sector.
You can, generally speaking, tell where the rules are being
tightened up by the number of brokers leaving the jurisdiction – just look at
the exodus from the US over the past five years. Some of it has been because of
the capital requirements placed upon firms, but just as much – probably more –
have resulted from the US insisting on brokers being just that. I am sure I am
not the only one who finds it ironic that brokers purporting to care for their
customers ship out the minute they are not allowed to trade against those same
The fact of the matter is that too many retail firms seek to
operate from the loosest available jurisdiction – that in itself should be a
warning sign. The question has to be asked: why do so many firms operate out of
Cyprus where there is, with all due respect to that lovely island, a limited
pool of talent? The population numbers suggest it is better to operate out of
London or Paris, or Frankfurt.
Last week’s announcement from ESMA and subsequently the FCA
in the UK suggest that even tougher rules are coming to Europe, which
inevitably begs three questions.
Exactly how tough will the rules be? Will Cyprus-based firms
have to adhere to these rules? And if they do, where is the next destination
for those firms looking for leeway within the rules?
One suggestion is Australia, which has had a bubbling issue
with the retail FX sector for some years. I know that, ASIC the regulator there,
has been warned in previous years about some of the practices in this space but
little has been done to date. This could be changing, however, for sources tell
me that ASIC has sent out a detailed questionnaire to firms offering retail FX
services. This survey could be, my sources think, a precursor to much stricter
oversight, which can only be a good thing.
I have listened to arguments for years now that the blurred
line between institutional and retail is no bad thing, but I look at the
approach to oversight as a great example of why there should be much firmer
demarcation lines. In the institutional space we have a Global Code of Conduct
(and a quick reminder to feedback on Principle 17 everyone – you only have
until September), which is principles-based and as such can be applied
In retail FX we have (much needed I believe) regulation –
something that cannot be applied globally. For this reason alone – that we are
operating under two different structures – I would argue there should be firmer
If that does prove impossible I have a simple solution to
helping stamp out potentially harmful (financially and reputationally speaking)
abuse in the retail sector. Actually make retail FX brokers operate as just
that. I have always disliked how hedge funds refer to banks as brokers – they
are not, they are banks, so let’s make sure that retail FX brokers are just
that. They should not be principals in any way, they should be a conduit, for
which they are paid brokerage.
We can dress it up anyway we like, but a bunch of firms
seeking to operate with a minimum level of oversight and who make money by trading FX markets against their
customers? I struggle to find anything good that comes out of that.