LeapRate was first to report last week on the Australia government’s move to change rules regarding what Retail Forex brokers, and those other regulated entities handling client money, can and cannot do with that money.
There seems to still be some confusion out there in Forex-land as to what those rules were, what they will be following the proposed legislative changes, and what they mean for the FX industry Down Under.
We are pleased to present a special guest post on the topic by Quinn Perrott. Quinn was a co-founder of AxiTrader, Australia’s largest domestic Retail Forex broker, and now runs TRAction Fintech which provides trade reporting services in Australia and the UK.
I read with interest the recent news that that the Australian Government will be proceeding with the proposed reforms to the Australian client money rules, effectively banning the use of client money as margin deposit with a prime broker (or Prime of Prime) for the purposes of hedging client positions.
The use of client money has been a long debated and discussed issue. In fact the Australian CFD and FX Forum was founded back in 2012, primarily to lobby for changes in the client money rules in Australia.
Unfortunately the debate became a partisan battle between competing interests and business models. I believe the debate has lost sight of what is in the best interest of retail clients and the industry.
Most Australian FX and CFD brokers have traditionally placed some of their client money with their prime broker to cover the margin requirements of their hedging activity.
Part of the reason for brokers generally needing access to client money to support their margin requirement is the discrepancy between the retail leverage offered to clients (often 400:1) and the leverage offered by prime or PoP brokers (from 20:1 to 100:1).
If a broker’s response was to lower the leverage offered to its retail clients, the clients would just go elsewhere. If the overall industry lowered leverage offered to retail clients in response to the changes then I think we would see a lot of clients move to overseas brokers. This was seen with Japanese retail clients when the Japanese government placed leverage limits on FX trading.
These changes will be welcomed by large brokers that are already running a B book, but resisted by smaller and less sophisticated brokers as these changes effectively put significant pressure on them. It also puts additional barriers for new players to enter the industry, further reducing competition.
Unfortunately this is not great news for Prime of Prime firms and fully STP brokers. PoP brokers may find their clients (usually smaller brokers) don’t have enough of their own capital to cover margin and will probably be forced to adopt a B book model.
Fully STP brokers will find hedging far too capital intensive without the use of client money, plus the return on capital often won’t be worth the risk.
For retail clients, in general I don’t see this as being the good news it may at first appear. I think there are a few cases in the past where it could have saved clients from losses but there are also plenty of examples where it would have made no difference. Even with client money staying in trust account there is still plenty of room for error, poor accounting and outright fraud.
Furthermore, these proposed reforms may reduce competition and severely limit the STP model, neither of these outcomes being good for the average retail client.
From my perspective, a more sensible approach would be for the government to impose additional oversight and reporting obligations regarding capital adequacy on brokers, and to require that the use of client money be limited to hedging of client positions.