It seems as if many regulators are now beginning to make important changes to the way retail Forex and Binary Options brokers will market their services.
The latest regulator to outline numerous potential changes it wants to implement is the FCA (Financial Conduct Authority) of the UK. This was presented in a recent Consultation Paper that was circulated in December. This was done in order to get feedback from the community on the changes.
The aim of the new regulations was to enhance a code of business conduct under which brokers could offer their services in the UK. This includes products including CFDs which are currently on offer to retail investors.
What are the changes?
The main changes that are being suggested include better disclosure of the risk associated with trading products such as CFDs and leveraged Forex. The broker must also clearly display the win-loss performance the average client can expect.
The draft paper also outlines some restrictions on leverage ratios that are allowed for clients who have less than 12 months of trading experience. This leverage ratio has been proposed at 25:1. Once the client has demonstrated a certain amount of trading experience then they should be entitle a leverage ratio of up to a maximum of 50:1.
Apart from the leverage ratio restrictions, the FCA wants to limit the use of Bonus packages which are often used with great affect to attract new clients.
The Potential Impact on Brokers
There is no doubt that the intentions behind these changes were to to reduce the total volume traded and clients trading. In fact, the FCA did its own cost benefit analysis on the impact of the report’s changes.
The regulator stated that “We expect that these measures will reduce the overall number of clients, the total volume and value of trades and total firm revenues.”
Firstly, the restrictions on trader bonuses will have an impact on their retention of clients. For many brokers, these bonus offers are an essential way for them to compete against much bigger firms with heavier online marketing. Some brokers are looking at other attractive alternatives to this.
Moreover, the requirement of numerous risk disclosure over all forms of advertising will impact on the number of new users who choose to trade CFDs.
When it comes the the leverage restrictions, the FCA estimates that approximately 40% of current retail clients could be classified as inexperienced investors and the rest as experienced. The FCA estimates that a broker earns about £400 from the latter and £3,500 from the latter.
With the changes to leverage ratios, client losses are expected to shrink by 20-40% which will no doubt shrink the average profit per trader.
How will Brokers and Clients Respond?
The impacts of these changes will impact brokers in an uneven way. Those who have a large client base of experienced traders will not be too badly impacted by the directives. Conversely, brokers who rely on new retail investors will no doubt be impacted negatively by the directives.
There is view among many brokers that these changes will increase possible consolidation in the industry. The cost of the regulations mean that only a limited subset of brokers large enough will have the financial means to be profitable and compliant.
However, it is not all doom and gloom for the smaller CFD brokers. Given that there will be higher margins required by the brokers, the minimum account size will have to be increased. This will mean that the smaller clients will be forced to look for alternative brokers with lower requirements offshore.
One thing is clear, the FCA will also need to consider that there are a number of world wide brokers who operate in other jurisdictions who will also stand with open books ready to take new traders should the rules become too onerous. Consumer protection is always essential but it should be done with precision.