It was on June 11, 2013 that Russia’s State Duma, the lower chamber of the country’s parliament, approved the proposed Forex bill at its first reading. Thus, the vote relating to the long-awaited document, which in its essence is a list of amendments to the existing law “On the Securities Market”, was successful, with 250 deputies supporting the bill. After this, expectations pointed to Russia being able to gain its Forex regulation as soon as the start of 2014. Alas, it has been more than one year since the first reading and the bill still awaits its second reading. This LeapRate Research details the basics of the current version of Russia’s Forex industry regulation and what happened (or did not happen) in this respect 17 months after the first reading.
The Forex Dealers
The official document set to determine the fate of the Russian OTC Forex market, is named “On the introduction of amendments to the Federal Law “On the Securities Market” and other legislative acts of the Russian Federation (with respect to the legal regulation of dealer activity in the over-the-counter Forex market)”. As its name suggests, the Forex bill is set to become an addition to an older law, dating back to 1996 – precisely the law on the securities market. The authors of the Forex bill explain that the inclusion of the bill in the existing law has amid its benefits the use of already established, approved and useful terminology.
The bill provides some basic concepts regarding the OTC Forex market (not only in Russia but also abroad), including what is a Forex market and what is considered an activity in this sector.
Most importantly, the companies operating in the OTC Forex market are given the status of Forex dealers. The main rationale for classifying Forex companies under the more general group “securities dealers” instead of “brokers” is that the dealers carry out trading at their own expense while brokers are meager intermediators. (Note – The lawmakers most likely took into account the fact of the so-called margin trading and that trading in the Forex OTC market is generally leverage-based and that leverage is provided by the Forex dealers). Hence, Forex brokers would lawfully be referred to as “Forex dealers” in Russia.
Lower Minimum Capital Requirements
One of the most painful issues concerning the regulation of Russia’s OTC Forex industry is the size of capital requirements. While at the first reading the lawmakers approved a rather high level, the latest decisions by the Bank of Russia point in the opposite direction.
The bill stated in its initial reading that the Forex trading firms will have to obtain licenses as dealers from the state regulator, a move that will impinge all Forex firms in Russia to comply with the requirements for securities dealers. Automatically, this triggers the question of minimum capital requirements. Under the existing version of the law “On the Securities Market”, every securities dealer in Russia should have a minimum net capital of RUB 35 million (USD 800,000/EUR 640,000) to obtain that license.
This makes Russia one of the expensive destinations to set up a regulated Forex broker. Of course, a comparison with the United States where “Each futures commission merchant offering or engaging in retail Forex transactions and each retail foreign exchange dealer must maintain adjusted net capital equal to or in excess of the greatest of $20,000,000” (CFTC regulations) is beneficial for Russia, but a comparison with the requirement for Cyprus Investment Firms – just EUR 200,000, shows that Russia may be losing a competitive edge in this regard. This capital requirement, however, is close to the one demanded for an Australian Financial Services License by the Australian Securities and Investments Commission (AUD 1 million). A similar demand looms in New Zealand where the Financial Markets Authority plans to impose an obligation for a minimum capital of NZD 1 million for Forex brokers regulated in the country.
The size of the capital requirement in Russia has been a source of concern for many companies in the industry. Many saw this proposal as a way to eliminate the small players from the Russian Forex market. Some insight on whether Russian Forex firms will be able to meet such an obligation is provided by the stats on the capitalization of Forex brokers participating in CRFIN, a Forex self-regulatory organization. The organization classifies its members in three categories (A, B, and C), according to their ability to meet their financial obligations to their clients; CRFIN also imposes different capital requirements to companies depending on their category.
Category A: Companies that have sufficient proprietary capital to meet their financial obligations to their clients in risky circumstances.
Category B: Companies that don’t have sufficient proprietary capital to meet their financial obligations to their clients in risky circumstances.
Category C: Introducing brokers and local offices of companies falling under categories A and B.
Category A: Minimum reserve capital of RUB 15 million (USD 426,580/EUR 315,410);
Category B: Minimum reserve capital of RUB 2 million (USD 56,880/EUR 42,050);
Category C: Minimum reserve capital of RUB 50,000 (USD 1,422/EUR 1,051).
The obvious conclusion is that the current capital requirements for the Forex brokers in Russia are way more modest than the ones envisaged in the FX bill. A more sensitive matter is how many Forex brokers would be able to meet the demand. Once again, the stats from CRFIN may be of help.
As of January 2014, the organization had 38 members, including:
Category A: 8 companies ( Alpari, EXNESS, FBS Trade, Fibo Group, Forex Club, IronFX Russia, Profit Group, Teletrade Group);
Category B: 9 companies ( Admiral Markets, Financial Investments, Forum, Fresh FX, Grand Capital, Larson&Holz Ltd, ROBO Trade, Romanov Capital and Rodeler Ru);
Category C: 23 companies (local offices of brokers, like EXNESS).
What the statistics clarify is that the capital demand is indeed rather high for the majority of Forex trading firms in Russia. No wonder then that there has been speculation about some extra division of Forex companies in the Forex bill, with different capital requirements to be proposed for institutional Forex brokers and retail Forex brokers.
Even if this speculation is mere speculation, there is still a piece of good news for future Forex dealers in Russia and it comes from the most stringent regulator – the Central Bank. In January 2014, Russia’s Central Bank which has approved a new version of a normative act called “On the norms of sufficiency of proprietary fundsof the participants in the securities market and the management companies of investment funds, mutual investment funds and non-state pension funds”. This document sets new minimum capital requirements for all participants in the securities market in Russia, including securities dealers, and Russia’s Forex brokers will be regulated as securities dealers.
Under the new rules, the minimum capital requirement for securities dealers is meager RUB 3 million (USD 76,000/EUR 60,000).
Instead of seeing one of the highest capital requirements in the world, the Russian FX brokers may actually enjoy the lowest ones, and indeed seven times lower than the initially proposed requirements. The proposal by the Central Bank is currently undergoing final stages of consultation and is poised to come into force once it gets published in the designated newspaper of the Central Bank.
The Importance of FX Self-Regulation
According to the current version of the Forex bill, all Forex dealers should have double regulation – on top of the regulation by a state body, they should take part in a self-regulatory organization (SRO). This part of the Forex bill makes perfect sense with regard to international expertise in well-established markets like the U.S., where along with the Commodity Futures Trading Commission (CFTC) there is the National Futures Association (NFA) in which futures commission merchants (FCMs) and retail foreign exchange dealers (RFEDs) are obliged to participate.
And yet, the SRO-part of the Russian FX bill has turned out to be quite problematic. It has met the objections of the State Duma Committee on Property, which called the idea for the creation of a single Forex SRO in Russia “a conceptual mistake”. The Committee insisted that creating a single SRO would turn it into a body that cannot be dissolved (that’s paving the way for corruption). At the same time, if this SRO is created in such a way that it allows it to stop functioning, then may be a moment when the SRO ceases to function and, hence, all the Forex brokers become illegal automatically. Another problem is that a single SRO may not be sufficient to handle the number of participants in the Russian Forex market.
The State Duma Committee found these issues so grave that it mentioned them amid the reasons for turning down the bill at its first reading.
What should be noted is that Forex brokers in Russia have one SRO in which to participate – that is CRFIN (Centre for Regulation in OTC Financial Instruments and Technologies). It combines all of the functions demanded from an SRO in the FX bill. Another good option for Forex brokers would be KROUFR (also known as FRA, or Financial Regulation Agency), which however is more of a dispute-resolution body than a full-blown SRO. And although CRFIN is the choice for more brokers (38 members) than KROUFR (7 members), many companies (like Forex Club and Fresh FX, for instance), have decided to participate in both. Moreover, KROUFR has an established reputation in tackling industry disputes and this is considered as a crucial factor in the importance of an SRO, as a recent study of Russian traders (by CRFIN) has found. It showed that 89% of the respondents believed that conflicts between brokers and their clients should be solved not only in court but also at the level of SROs.
By all means, Russia’s Forex SROs will need plenty of time to reach the status and importance of their US counterpart NFA – the latter boasts the membership of 4,100 firms and 57,000 associates.
The Russian SROs would share most of the functions of their US counterparts – making sure that Forex dealers obey the law; developing industry standards; arbitration; drafting advertising rules, etc. One can easily see that these organizations would assume a huge part of the responsibilities for the oversight of the Russian Forex industry.
Tougher Rules for FX Advertising
The current version of the FX bill gives self-regulatory organizations the power to set standards for advertising of Forex products and services. This is crucial at this moment, as the chapter on advertising in the law “On the Securities Market” went out of date in February 2007. Thus, the regulation of Forex ads is left to the existing law “On Advertising”, which is more general and does not take into account the specifics of the FX industry. Then, there are the standards to be set by the SROs. To have an idea what these would be we may take a look at the current advertising rules, set by CRFIN.
“8.2. When advertising its services, a Forex company should not:
8.2.1. show information that cannot be confirmed by the necessary documents;
8.2.2. show incorrect information about its activity or other information, set to deceit or mislead existing or potential clients;
8.2.3. make an impression that getting profits as a result of conducting operations with the advertised instruments is guaranteed;
8.2.4. include any links or referrals to actual trading profits from the past without mentioning that past results are not associated with possible future results;
8.2.5. show expected size of profits from operations with the advertised financial instruments, based on forecasts of price changes;
8.2.6. address minors.
0.1. When advertising its services, a Forex company should mention the risky nature of trading operations and, in particular, specify that the chance to get profit is linked to the chance of suffering losses.”
The direction suggested by Russian authoritative figures is towards stricter rules for Forex advertising. If we consider the comments of Sergey Shvetsov, Member of the Board of Directors, Deputy Chairman of Russia’s Central Bank, the Forex industry faces advertising rules similar to those for the tobacco industry. Amid the most famous comments made by Shvetsov is the phrase that “Forex is dangerous for your wallet as smoking is dangerous for your health”. He demands more rigid rules for Forex ads, including stark warnings of the risks involved in this sort of trading.
Another of the landmark comments by Shvetsov concerns the Forex brokers with non-Russian headquarters (registration), willing to advertise their services to Russian clients. He advocates the “exclusive right” of Russian Forex brokers to such adverts, that is, he insists that Forex brokers not licensed in Russia should not have the right to advertise their services in Russia. Whether such restrictive measures would come into force should become clear at the time the second-reading version of the FX bill is present. Perhaps, these new rules would be included in the Chapter 9 of the law “On the Securities Market”, the chapter dedicated to advertising in the securities market. One issue to be considered here is, however, the danger of breaking competition rules with such restrictive measures regarding foreign businesses.
The Megaregulator to Oversee the Forex Industry
One of the changes the Forex bill will necessarily undergo before the second reading concerns the state regulator of the industry. When the bill was first drafted in the end of 2012, the designated regulator was the Federal Financial Markets Service. But this body was eliminated in March 2014, as the oversight of the entire financial industry in Russia gradually shifted to a single regulator – the Central Bank. A separate department in the Bank will oversee the Forex industry, once the proper law is there.
Many brokers are concerned by the lack of a separate regulator for the FX industry and the fact that the complex bureaucratic apparatus of the Central Bank is a hard nut to crack. And although the administrative expenses for getting that dealer license amount to several hundred dollars, the procedure itself looms as the biggest problem – it appears to be too clumsy.
The Tax Net Gets Wider
When the FX bill was presented for its first reading, it was accompanied by Financial Justification – a document depicting the benefits of the new legislation for the state coffers. The biggest plus, as expected, are the extra revenues from taxes to be paid by Russian Forex brokers. The estimates in the paper point to tax income of between USD 23 million – USD 43 million during the first three years following the coming into force of the law. Around 15-30% of this sum is to enter the state coffers in the first year after the law comes into force.
The estimates (actual in the spring of 2013) show there were some 60,000 traders with positive balance in their Forex accounts, with their average income from Forex trading at $1,800 annually. Having this in mind, the expected revenues from these taxes are USD 14 million per year.
The new development in this respect over the past year are the proposed changes in the tax code by Russia’s Ministry of Finance. Under the new rules, which have yet to come into force, the tax net will be cast outside of Russia too, covering the 41 offshore zones as stipulated by the Russian law.
3. Antigua and Barbuda;
5. The Bahamas;
6. Kingdom of Bahrain;
9. Brunei Darussalam;
11. The British Virgin Islands;
14. The Commonwealth of Dominica;
15. People’s Republic of China:
Hong Kong (Xianggang);
16. Comoros: Anjouan;
20. Malaysia: Labuan Island;
21. The Maldives;
23. The Marshall Islands;
27. The Netherlands Antilles;
29. United Arab Emirates;
30. The Cayman Islands;
31. Cook Islands;
33. Republic Palau;
36. San Marino;
37. St. Vincent and the Grenadines (SVG);
38. Saint Kitts and Nevis;
39. Saint Lucia;
40. The UK and Northern Ireland, Isle of Man; Channel Islands (Guernsey, Jersey, Sark, Alderney);
41. Seychelles Islands.
The new rules mandate that any Russian individual or business holding at least 50% in an entity in an offshore destination would pay taxes with the proceeds to go to the Russian state coffers. The tax net gets wider and two years after the new rules come into force, all Russian individuals or businesses holding at least 10% in a controlled foreign company (a company with Russian shareholders in an offshore zone) should declare their holdings to Russian authorities and pay taxes.
For business entities the tax rate is 20% of the profit of the offshore business, clear of dividends; while for individual shareholders the rate is at 13%.
Obviously, a great proportion of Forex brokers will be affected. If we consider the data from the latest Interfax study of the Russian Forex industry, in 2013 there were some 90 Forex brokers soliciting Russian clients, with the bulk of them not having offices in Russia but registered in offshore zones like the British Virgin Islands or Belize. Hence, the Russian regulators will not formally force the brokers to register in Russia but will still manage to gather taxes from them.
A short note should be made about the status of Cyprus in terms of offshore terminology. In January 2013, Cyprus was excluded from the Russian list of offshore zones. Speculation says that it will be included in the list once again – a move that may have consequences for Forex brokers with licenses as Cyprus Investment Firms and business exposure in Russia.
Another interesting question is the possibility to implement such rules – in order for such a wide tax net to be in place, Russia needs the close co-operation of international organizations and the Organisation for Economic Co-operation and Development (OECD) in particular. However, negotiations between Russia and OECD have stalled amid the Ukrainian crisis, so we can hardly expect any fast developments in respect of offshore tax collection.
Transparency and Standards for Reporting
One of the main tasks of the regulator responsible for the Forex industry in Russia is to determine the standards for reporting key data and publishing certain information.
At this moment, some Forex brokers active in Russia (like Alpari and EXNESS) publish their trading volumes data each month, while others (like Forex Club, AForex and Fresh Forex) update the public each month on the percentage of profitable and loss-making clients. The transparency has been boosted thanks to some of the firms hiring external auditors to confirm the accuracy of the metrics reported. And yet, the lack of uniform standards for reporting dissuades many of the companies from revealing their operating and financial metrics.
Restrictions on Leverage
The current version of the Forex bill does not determine any limits on leverage – in fact, it does not mention “margin” or “leverage” at all. However, as the bill got stuck in the Duma, lawmakers have been increasingly commenting the possibility of a cap on leverage.
According to the latest information on the matter, CRFIN has recommended a maximum level of 1:100. Sergey Shvetsov – one of the key figures in the development of the revised FX bill, has thrown his weight behind.
Many fear that a strict cap will hamper FX trading in Russia, bringing its rules in line with jurisdictions like the United States, where the cap is at 1:50 for majors and at 1:20 for minors, and Japan, where the leverage cap is even lower at 1:25.
The planned leverage limit for Russia will inevitably entail changes in trading terms and conditions at many brokers, as leverage offered by Forex brokers currently operating in the country reaches 1:500 and even 1:1000. Many believe that such limits will deal a blow to Russia’s Forex industry in terms of international competitiveness. Markets like Cyprus and Australia have been attracting Forex brokers partially thanks to a lack of maximum leverage limits.
Crimea’s Effect on Forex Regulation
Although the issue of Crimea’s political status and the relationship of the territory with Russia may seem to have little or no relation with the pending Forex regulation, the matter is in fact connected with the legislative work in this field. In fact, the State Duma committees responsible for the Forex bill – the Committee on Property and the Committee on Financial Markets, have been pre-occupied with work on all legislative acts for the new territorial entity: its budget, currency, etc. This has deflected their focus from the Forex bill. And it is the Crimean issue that was mentioned by Vadim Vinogradov from CRFIN as the main reason for the last postponement of the second reading of the FX bill.
It has been more than a year since the first reading of the FX bill in Russia and as the second reading looms we expect a lot of changes:
− The minimum capital requirements for Forex brokers are set to be markedly reduced;
− The maximum leverage is poised to be strictly limited;
− The tax net will be cast wider and will include offshore companies;
− The advertising rules will be stricter;
− There may be more than one self-regulatory organization;
− The brokers/dealers will be classified in different categories;
− The Central Bank will assume oversight of the FX industry.
To see which of these changes are implemented we need to wait for the second reading of the bill, which is scheduled for November 11, 2014.
1. Text of the Forex bill as approved at the first reading.
2. List of normative acts approved by the Central Bank (in Russian).
3. Website of CRFIN: Self-Regulatory Organization Non Profit Partnership “Centre for Regulation in OTC Financial Instruments and Technologies”.
4. Website of KROUFR: Commission for the regulation of relations on the financial market.
5. Latest Interfax study of Russia’s Forex market.