Op Ed: Who are the real regulators?

Non-bank financial services regulation was relatively unheard of before the 1980s, and indeed even after the establishment of the Financial Services Authority (FSA) in the United Kingdom during the boom times of Prime Minister Baroness Margaret Thatcher which after 28 years became the Financial Conduct Authority, it was still a number of years before many other nations adopted regulatory structures for non-bank activity including retail electronic trading.

During the last five years, a period of rapid development in the FX industry, a number of national regulatory authorities have become synonymous with FX, indeed so much so that consumers view the regulatory seal of approval from Cyprus, Australia, Britain, the United States and Japan with the same level of conviction reserved for nutritional certification on food packaging.

So automatic is the acceptance by retail customers of regulatory symbols and acronyms which adorn many retail FX and binary options websites, that the question often asked is whether a particular company is regulated, rather than by which authority and how said authority will serve the best interest of the client should things go awry.

Disastrous events within the FX industry are often forgotten very quickly, partly due to the rapidly developing nature of the business as well as the eager nature of retail investors drawn by large potential gains, therefore two of the most poignant examples of corporate failure in North America have largely become a distant and very feint memory. Peregrine Financial Group, known colloquially in its heyday as PFGBest, was shut down in July 2012 after it was put under investigation for a $200 million shortfall in customer funds by the US government.

Peregrine’s chief executive, Russell R. Wasendorf Sr., was arrested and charged with making false statements to the Commodity Futures Trading Commission (CFTC), and at the time of bankruptcy the firm listed more than $500 million in assets and over $100 million in liabilities.

This, along with the catastrophic failure of MF Global, lead to government-level action in the reformation of how OTC derivatives are provided, reported and executed within the Dodd-Frank Act.

The United States has a long tradition, dating back to the days of the 1950s automotive industry about which politician Ralph Nader wrote the book “Unsafe at Any Speed”, lambasting the lack of regard for consumer safety, having a dramatic effect on the public perception of companies and their responsibilities. For many years since, America’s automobile companies enjoy a fine reputation for high safety standards – but would this have been the case if it weren’t for Mr. Nader’s scathing attack which hit General Motors, Ford and Chrysler in the pocket? Probably not until it were too late, and the automotive equivalent of PFGBest or MF Global occurred.

So it follows with financial markets regulation. The National Futures Association (NFA) receives a great deal of unwarranted discourse from many FX industry participants, however, let’s face it, the NFA holds itself out clearly as one of the only true regulatory authorities in the world.

Yesterday’s announcement by the regulator that it was going to put an end to the possibility of using credit cards to fund FX accounts by retail customers in the United States is a perfect example of the regulator’s preventative measures which in the end will serve the industry well.

As consolidation among FX companies is at an all time high, with two giants – GAIN Capital and FXCM battling it out for supremacy, purchasing client bases of other firms, entire FX companies and specialist software and ancillary organizations, these publicly listed, highly respected global corporations have a responsibility not only to their vast array of clients but also to the US economy, shareholders, and indeed their own operations.

By banning credit card deposits, the United States government can ensure that companies are protected from fraudulent activity, money laundering, and exposure to chargebacks and high risk factors that can cause endless problems for large firms.

Additionally, this ruling will engender more experienced traders to take a long-term view and invest larger capital sums over a longer period of time, thus stabilizing the US traders’ entire livelihood, as well as engender a better quality flow of business for companies, and reduce the possibilities of regulatory censuring due to mishaps relating to traders losing money that they do not have, after speculating on a market in which they are unfamiliar.

This is the absolute definition of consumer protection whilst acting in the best interests of large companies.

Should a firm commit wrongdoing under the auspices of the NFA, or indeed the CFTC for that matter, often the resultant action takes the form of a court case against the brokerage or technology provider, followed by trial and charges, which then culminate in not only fiscal penalties but censuring of the directors and disgorgement of ill-gotten gains in order to compensate customers for their losses.

Should this not be enough, each company must lodge $20 million as net capital, which must be held with the brokerage as the NFA member, so therefore if the disgorgements do not cover the loss, the net capital should do so. NFA members face severe penalties for misusing this portion of capital for operational purposes.

By contrast, many of the world’s other regulators, despite their popularity and the sense of security that viewing the symbol of the regulator on a brokerage website offers, are purely there to engender a specific type of business activity in a specific region, or to mediate between client and company in case of adversity.

An example of this is CySec, an organization which quickly embraced FX as a priority in 1988. Suddenly, as retail FX became popular and Cyprus joined the European Union, CySec’s CIF license offered companies in Cyprus the opportunity to provide regulated services to clients all over Europe, including in Great Britain, without having to go through the lengthy and expensive process of basing their operations in London and gaining an FCA license.

As a result, FX companies have flocked to Cyprus over the last five years, with clients from all over the world resting in the knowledge that they are operating with a regulated entity.

The difference is, however, that the NFA’s remit is to ensure that the investing public is totally protected, whereas CySec’s interest is in attracting FX brokerages to Cyprus and ensuring that they maintain their presence there. For this reason, setting up is very straight forward, capital adequacy requirement is low at 730,000 Euros, and fines, which are rare, are often very affordable.

Indeed, many regulators are akin to a gentlemen’s club, a trade organization which members pay their subscriptions to each year in exchange for association and kudos.

Even the FCA, which is highly respected and has interest in ensuring the fair treatment of clients, very rarely acts upon a company which is the subject of a complaint. Instead, the FCA issues allegations concerning any complaint to the company in question, following which the company often offers a financial settlement before any action is taken, 97% of which have been accepted by the FCA between 2010 and 2013, hence companies being hauled over the coals is very rare.

As far as establishing a company in London is concerned, the FCA’s application process resembles that of a self-regulatory organization in that an application form must be completed, with the brokerage able to set parameters such as how much net capital it requires to safely operate its business – thus some have $1 million, some have $25 million, and how many key employees are required as well as what type of business the firm wishes to conduct. These variables can cause applications to take between fifteen months to three years.

Recently, Charles-Henri Sabet’s purchase of London Capital Group via a £17 million financing initiative was partly influenced by the ability to buy a London-based entity which already had FCA licensing and thus Mr. Sabet detailed to me that this was far easier than going through the entire licensing procedure from scratch. Indeed, the FCA had to approve Mr. Sabet’s financing plan, but this was a lot less bureaucratic than if establishing a company from the beginning.

Australia’s national regulatory authority has taken a different approach altogether. The Australian Securities and Investments Commission (ASIC) employs an electronic surveillance system provided by British financial software company First Derivatives to monitor real time financial markets activity. On finding irregularities, the regulator proactively charges the company concerned and asks for either an Enforceable Undertaking that the company has rectified the matter, or a predetermined fine is imposed.

This has propelled ASIC into the realms of the NFA as far as being a stringent regulator is concerned, with genuine interest in censuring, or even closing down, companies that do not comply.

With so much inter-government discussion among G20 countries about cross-border regulation, there is still very little likelihood of a client of a British company who lives outside of the European Union, or a client of a New Zealand company who lives in Australia or the Far East actually being able to seek rectification from the respective national regulators in the case of a complaint arising.

Japan’s Financial Services Agency is aware of its lack of jurisdiction over other regions, therefore the company sent a message to various European regulators in the summer of 2013 asking that Japanese customers trading with firms outside Japan should ask permission from the Japanese regulator before doing business with a European company.

ASIC, the CFTC and the NFA are quite different in the respect that they will often take action against firms even if the company or the transgression has not taken place on home soil. In June last year, the CFTC issued charges against Banc de Binary for soliciting US clients to invest in off-exchange binary options, an asset class that is illegal in the United States as exchange traded binary options is mandatory, resulting in a law suit against the firm which is not yet resolved, subsequently including the company’s CEO in the proceedings, despite being based outside the United States.

ASIC recently put an end to Pepperstone’s presence in Japan, thus detailing that as Pepperstone is an Australian company, ASIC has jurisdiction over what it does abroad.

As part of ASIC’s ongoing monitoring of the retail derivatives and margin foreign exchange industry, ASIC became aware that Pepperstone was also advertising its products through a Japanese mirror website and that it has a number of clients based in Japan to whom it offers margin foreign exchange services.

An Australian financial services (AFS) licence only permits AFS licensees to carry on a financial services business in Australia. It does not permit AFS licensees to offer financial services in other jurisdictions where approval may be required from the local regulatory authority.

On this basis, it is worth bearing in mind that not all regulators are equal, and that some offer the placebo effect of a symbol, which resembles a straw man, whereas others are extremely powerful and committed to consumer security as well as engendering the all-important longevity of the FX industry, both of which are matters crucial to the survival and growth of the entire business as a whole.





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