ODP licensing: Big changes for Forex regulation in 2020
JOHANNESBURG – Online forex trading is a relatively new phenomenon in South Africa – and one that is looked down upon as little more than gambling by many people.
Forex trading’s reputation in South Africa has been plagued by story after story of con-artists and scams. We have seen men with colourful names (I’m looking at you ‘Cashflow’) prosecuted by the Financial Services Conduct Authority (FSCA) and convicted of defrauding their clients and more men with colourful names (the ‘FBK Millionaires’ this time) being accused of operating illegally. It seems like every few weeks another so-called Forex scam is revealed.
I say ‘so-called’ because while these people are certainly running scams, with all due respect to the FBK Millionaires, do they have anything to do with what is commonly recognised as Forex trading? Not really.
Scam? Yes! Forex trading? Probably not
Most of these scams that we see are variants on pyramid schemes, or the closely related Ponzi scheme (named after another colourful character who is ‘credited’ with popularising the sordid enterprise), and Forex trading is just a disguise used to cover the crime.
In fact, there is very rarely any Forex trading involved in these schemes at all. The criminal operator will know enough to sound knowledgeable and may even offer to share his secrets with his victims, usually for thousands of Rand, but these criminals are very rarely financial geniuses, or why would they be scamming people in the first place?
The real problems with Forex trading in South Africa lie in two distinct areas: The first being a lack of education among new Forex traders and the second being a few bad Forex brokers who should be put out of business.
But what is the FSCA doing to put these brokers out of business? And what are they doing to make sure new Forex traders are educated?
Consumer Protection and the FSCA
The FSCA has its roots in the old Financial Services Board (FSB), which was founded as part of the FAIS act in 2003 to deal with corruption and improper dealings amongst insurance and pensions companies. These days the FSCA is well-respected as a competent regulator of traditional financial companies.
But when it comes to Forex trading the FSCA are about to take a giant step into the future.
As mentioned earlier, Forex trading in South Africa has two main enemies – lack of financial literacy amongst new traders, and bad brokers. The FSCA is about launch a new regulatory regime that has these two targets firmly in its sights.
The ODP licence
The new regulatory regime, known as the Over the Counter Derivative Provider (ODP) licence, requires brokers to conduct due diligence on their clients before they can trade high-risk products, introduces stricter capital adequacy requirements and forces all Forex brokers (and other ODP companies) who have a physical presence in the country to provide continuous access to all transaction data to the FSCA.
This last point means that the regulator will have access to all transaction details, including the instrument type, underlying asset, price, leverage used and the investors name and country of residence. Though this may seem like an onerous responsibility to place on brokers, it is designed to ensure that brokers treat all clients fairly and do not engage in unprincipled or illegal activity.
All eyes on the FSCA
So far, the FSCA’s new regulatory regime is being met with cautious optimism by the local industry. Jimmy Moyaha, an Independent Consultant in the financial markets space, is clear that real change is much needed: “There isn’t enough emphasis on running a brokerage in a legal manner under the current regime. The current regulations were created to govern the insurance industry and other traditional financial companies, it doesn’t really work for exchange-traded products or CFDs. With this new regime it’s a real chance to clean up our industry – the local industry has gone through a difficult time recently, we have seen a lot of Forex scams and it is very difficult for legitimate providers to conduct business in an environment where consumers are regularly getting scammed.”
Having interviewed several highly reputed Forex brokers operating in the local market, this is a recurring theme – that scams and bad brokers are doing real damage to the industry. The more people read about Forex scams, and the more people fall victim to unscrupulous brokers, the more the reputation of the industry suffers. And this is something that the legitimate brokers want put right as soon as possible.
As Moyaha points out: “We have a real opportunity here with the ODP licence to clear out all the bad apples, sweep out all of the junk that’s in the local industry and create a cleaner market. These new regulations will cover how brokers look after their clients and how they maintain their products and will examine what kind of execution model a broker uses – all factors which should make bad brokers easy to catch. Because our products are highly-leveraged products, they are inherently risky products and it’s important that they are tightly regulated. That’s why the ODP licence has been created, I believe, the vision behind it is to clean out the bad apples and start again.”
Other brokers we talked to were less sure that the ODP licence in its current form is a good thing for the industry, not because more regulation isn’t needed but because the new regulation is not built for the South African market and is not going to be enforceable.
Another FSCA regulated, award-winning broker with many years’ experience in South Africa would only speak to us on condition of anonymity. One of their concerns was that the FSCA had not engaged enough with the local industry before deciding on the new regulatory regime: “Frankly, in our industry the cost of compliance is very low – and when the cost of compliance is very low, there is an incentive for business to push the boundaries, to experiment, to try and find way to circumvent whatever legislation has been put in place. So, anything apart from full engagement [with the Forex broking industry] will end in a situation where the FSCA and the market players will be diametrically opposed and that will not end well for anyone.”
“What are the advantages of this new regime? Because, as it is, I don’t see much. I wish they [the FSCA] had gone further, in terms of the suitability requirements for traders and the integration of trading records between market players.”
Planning a safer market
As it stands, the ODP licensing regime is still in the application phase, so it remains to be seen exactly what its final form looks like. The FSCA is certainly planning a safer, more transparent and better regulated market and once the new regime is up and running, we can expect the FSCA to take a more active role in ensuring the safety and education of traders and potential traders.
There remains the concern though, that the new regime will just be redecoration rather than a complete overhaul of the market. Another FSCA-regulated, South African broker said; “we have been in business now for over four years, we have never had an onsite inspection from the FSCA in all that time.”
“They have never audited us – they rely on the audits sent to them by the compliance officers. Every month the compliance officer sends through their audit, but these are completely desktop-based. And this honestly worries me.”
“It’s an open secret, there are a few bad apples in the local market. But you are never going to get rid of them by relying on desktop audits. This is the kind of thing I have brought up with the FSCA, the importance of [on site] inspections. And if they do start making these kinds of inspections, they will… become better regulators.
So, it seems that how well the new regime protects traders will depend on how well enforced it is by the FSCA. Based on the FSCA’s strong regulation of the Johannesburg Stock Exchange and the insurance industry, there is a good chance that they will perform admirably, but some good brokers are worried that we might be looking at a change of the letter of the law without any real change in reality.
The FSCA was approached for comment but no official response has been received. We will update this article once we receive a statement.
Chris Cammack is Head of Content at www.TradeForexSA.co.za.