Analysis: Land of the Free, Home of the FX Broker

If you’ve been fretting over leverage caps and marketing restrictions in Europe, spare a thought for your comrades across the Atlantic Ocean in America.

Back in 2006, there were forty different retail brokers operating in the Land of the Free. Just over a decade later, that number is down to five – IG US, Ameritrade, GAIN Capital, Oanda and Interactive Brokers.

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The reason for that precipitous decline was the implementation of the Dodd-Frank Act in 2010. Along with a host of other regulations aimed at protecting retail customers in the financial services industry, Dodd-Frank massively upped brokers’ capital requirements.

Any retail foreign exchange (FX) broker operating in the US must have a minimum of $20 million on its balance sheet at any given time. On top of that, firms must maintain 5 percent of customer liabilities that exceed $10 million.

Too much money

These requirements sent most brokers scuttling out of the US faster than you can say “Larnaca Airport.” Others that remained behind were stripped of their regulatory licences in the wake of the 2015 Swiss Franc debacle.

“Many of the brokers operating in the US prior to Dodd-Frank were more centered around sales and marketing, with less focus on compliance, regulation and reporting,” said Justin Hertzberg, the CEO and founder of US-based introducing broker Forest Park FX.

“As a result, they were not well-equipped for these changes and likely found that focusing on markets with lower operating barriers at the time, such as Europe and Australia, were a better use of resources.”

In many ways brokers are still much better at marketing and selling than they are at following compliance procedures and adhering to regulations. But just as Dodd-Frank swept through the US almost a decade ago, the European Securities and Markets Authority’s regulations have put a damper on brokers operating in the EU.

Across the world in Australia, arguably the last jurisdiction to be both permissive to retail brokers and have a respected regulator, financial authorities are also making noises that would seem to indicate leverage caps, higher capital requirements and marketing restrictions are on the way.

Relatively speaking

All of this has, in turn, made the US seem like a more attractive place for brokers to do business, even if the rules that forced them out in the first place remain in place.

“I don’t think renewed interest in the US market is so much a response to ESMA restrictions as a global re-evaluation of jurisdictions,” Quinn Perot, the co-CEO of compliance consultancy firm TRAction Fintech, told Finance Magnates. “The US is looking more attractive on a comparative or relative basis than it did a few years ago.”

Evidence of this came in early February of this year when, a couple of months after receiving regulatory approval to do so, IG Group launched its US subsidiary – IG US.

Like many of its competitors, IG’s retail FX business shut down in 2011 following the introduction of Dodd-Frank. But the firm didn’t leave entirely.

Open market

Since 2008, the London-based brokerage has been operating Nadex, a US-regulated binary options exchange. Then in 2016, the group purchased DailyFX, a retail trading news portal, from FXCM for $40 million.

“Our decision to expand our operations in the US was completely unrelated to ESMA’s regulatory changes in the EU,” IG communications director Ramon Kaur told Finance Magnates.

“In the US we identified a large market opportunity for IG and a serious need that US retail FX traders have for better service, product innovation and quality spreads. We recognise that the current US market is significantly underserved and this presents an opportunity. In addition, we have a great opportunity to access DailyFX’s broad base of devoted US readers.”

Kaur’s comments point to another reason why brokers might be considering heading back to America – there aren’t many firms doing business there. That has to be a breath of fresh air for brokers, most of whom are operating in the extremely saturated European market.

And though the numbers aren’t huge, we are starting to see some more activity in the US market. Three brokers are waiting to be confirmed as Retail Foreign Exchange Dealers (RFEDs) by the National Futures Association (NFA) and all of them applied this year.

eToro, another major player in the retail trading space, also entered the US market in March with a cryptocurrency offering. Though it is yet to apply for the requisite licensing, the social trading firm has plans to expand its US subsidiary’s set of products to include an array of different asset classes.

“We’re working to make equities trading accessible to U.S. customers,” said Guy Hirsch, eToro’s US managing director. “And we hope to make eToro US a multi-asset platform by the end of 2019.”

Stocks first, FX later

That Hirsch’s firm is thinking of turning to equities before FX illustrates a key difference in the US market. European and Australian brokers have focused heavily, some might say solely, on offering CFDs and currency trading.

Conversely, US firms are much more accustomed to offering other products, especially equities. That’s in part because they cannot offer CFDs but, as the success of firms like Robinhood illustrates, it may also be due to a preference amongst American traders.

“Business culture is something that a lot of companies overlook when moving to the US,” said Perot. “If you look at brokers in the UK, Cyprus and Australia, they all work in a similar way. The US is quite distinct from that, people are much more familiar with equities and futures.”

For IG Group, cultural challenges are likely to be easier to overcome. As noted, the firm has already been operating its binary options exchange in the US for over a decade and the flow of traders from DailyFX may expedite the process of onboarding new clients.

“Running Nadex for ten years has certainly helped us,” said IG Group’s Kaur. “Particularly in terms of understanding the trading environment for individual, self-directed traders in the US.”

Better knowledge, bigger deposits

One way in which firms may actually benefit from a different trading culture is that Americans appear to have better knowledge of the financial markets than other retail traders across the world.

Given that low-end retail clients have often caused massive problems for brokers through complaints, that’s a real positive for retail trading firms – especially as many now claim they are focusing their efforts on attracting a higher end clientele.

Still, according to Hertzberg, many of the demographic features of retail traders in the US are akin to those of upscale brokerage clients across the world. So, even if they are better educated in terms of finance, they still closely resemble the sorts of people that companies are used to targeting via their marketing efforts.

“Through our own research, we have found that US clients tend to be more financially savvy [than other retail traders] and this is reflected in deposit sizes that are, on average, about two times greater than non-US clients,” said Hertzberg. “But the demographics, backgrounds, disciplines and interests in the FX market are otherwise pretty similar to the rest of the world.”

Despite all of these positives, entry into the US market is still – for most firms – prohibitively high. Thus, even though there may be growing interest in America amongst brokers, it’s unlikely the market will grow to the size it was a decade ago.

“Most small brokers just don’t have a spare $20 million to cover the capital requirements,” said Perot. “Even if they did, they need a large turnover to get a fair return on that capital, so, at least for now, it’s big boys only.”

Still for the big guns

That may be the case but it’s also true that there are a number of big players active in the market. And, even if their revenues have slipped over the past six months, they do have the ability to move into the US market.

“I do think we are likely to see more brokers operating in the US,” said Hertzberg. “But, absent a change in regulation, I don’t see there being more than 10 brokers getting approval to operate as RFEDs.

“If you ask industry people, they would likely all say they want to take on US business, but the regulatory requirements are too onerous and difficult to overcome – and that is why they stay away.”

Describing his decision to join the GOP, Ronald Reagan famously quipped; “I didn’t leave the Democratic Party, the Democratic Party left me.”

And just as Reagan felt he had remained the same while his political party arched away from him, global regulatory changes and a lack of competition mean that the retail FX market in the US, even if it remains the same as it was after the introduction of Dodd-Frank, has become a more attractive option for brokers. Now all they have to do is find $20 million so that they can get that NFA license.

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