Today is a very windy day in Cyprus. I am looking outside to the sea and spot some wind and kite surfers on the blue Mediterranean Sea. They all seem to go and return with the same inclination towards the wind which gives them direction and speed with occasional bumps on the waves here and there. The easiest way to know the direction of the wind is to check the direction of the bubbles on the surface and the direction of waves themselves. Everything looks normal, people seem to be enjoying their time, they know where they are headed and how to come back to shore. Some seem to be more professional, others are beginners who want to become professionals. There is order and comfort in this setup.

In the European retail FX industry there is less order and stability as there are constant regulatory changes taking place. The industry is hit with new regulations, restrictions, bans almost every week now. One day you were interviewing people for a BD position in France and the next day you realized that it is not at all feasible to build any business there. A bit later you have the same thoughts about Belgium, Spain, Turkey, Ireland, … .

It’s like you go out with the friends to play football, then after 5 minutes the game suddenly turns into hockey, then tennis and eventually you completely lose your focus. How can one make strategic decisions in such an environment?

We are currently all waiting for the UK FCA to decide if, how, when and for whom they will implement changes in terms of the the maximum allowed leverage and some other critical aspects of the retail FX and CFD business. The decision by the UK FCA will impact not only the UK and the EU brokers but eventually also the markets elsewhere because other regulators tend to follow the guidelines of the FCA.

Over the last couple of weeks we have already seen a lot of the CySEC regulated brokers lowering the maximum leverage for experienced retail clients from the previous 1:500 to the range of 1:200 to 1:300. Brokers which still provide 1:500 have removed such information from the front page. In general it is good because it limits the excessive interest from small non-professional clients.

What kind of leverage retail FX traders really want?

When we were actively trading on the commodities futures and futures options market then the leverage available was mostly 1:15 to 1:30. I remember when we moved 7 years ago into FX brokerage business then it took me actually quite some time to fully comprehend what a leverage of 1:500 means. I get the similar feelings today when I think about what lies after the end of the universe.

A flash research I did this week among some of the larger European retail FX brokers indicate that more than 90% of the retail trading accounts enjoy the maximum leverage available from the broker (in most cases 1:400 to 1:500). In majority of the cases where the default initial leverage set by the broker is 1:50 the clients still request that the leverage be hiked to the maximum.

You can feel substantial frustration among the retail clients of the European regulated brokers due to constant changes in the leverage policies and other terms. This affects negatively also the profitability of the clients because they constantly need to adjust their risk management approach and trading strategies. It creates stress.

The logic from the clients’ perspective to demand higher leverage is that they want to increase their profit potential. Most of the retail FX clients have limited investable capital which means that in a lot of the cases they are not able to meet the minimum deposit threshold of serious regulated stock, futures and options brokers. So they are left with the leveraged FX and CFD brokers where minimum deposit is generally low but they can expose themselves to bigger positions and earn substantial profit should the decision be right. Of course not a lot of people can make the right decisions over a longer time span but this is true not only with FX traders but also with stock, futures and options traders. Markets are complex and trading is one of the most difficult jobs.

As the retail FX brokerage industry is one of the most competitive industries in the financial sector, where globally we have between 3 – 4,000 brokers competing cross-border for the same client then obviously the brokers want to provide such leverage that the clients demand. I have not seen a single EU regulated broker who forces the clients to take high leverage – it is voluntary.

When you combine ignorance and leverage, you get some pretty interesting results. Warren Buffet

When we were running retail FX brokerage business with Armada Markets then there was one specific case which comes to my mind. In October 2014, we decided to lower significantly the maximum leverage on all CHF pairs. This was 3 months before the EUR/CHF flash crash. Our clients had around 400 lots open buy position in EUR/CHF alone which they had held for months because of the 1.2000 floor that was firmly protected by the SNB. Following our reduction of leverage, 95% of all of these positions were closed by the clients and they left. It is interesting that once the EUR/CHF floor was removed and the pair crashed, all of these clients figured out that we actually saved them from huge losses and they eventually came back.

The moment a broker lowers significantly the maximum allowed leverage is the moment it loses some of its clients and the clients who remain will trade less volume because they are able to open smaller positions.

In February, 2017 the Capital Markets Board of Turkey, the Turkish regulator, lowered the maximum leverage available for small retail clients to 1:10. It did this without having any extensive discussions with the local market participants which together employ roughly 6-7,000 people in Turkey. Some of the Turkish brokers have now closed their business while the Turkish clients who previously enjoyed the services of local brokers which were governed by the local regulator have now mostly shifted their equity from Turkish banks to bank accounts of foreign brokers where they can enjoy the same maximum leverage they had previously in Turkey. So in short, Turkish brokers lost business, Turkish clients lost local support and local regulatory protection while all major global brokers can tell you that in recent months they have grown significantly their Turkish business. I still cannot figure it out where is the logic behind the regulator’s move. I will keep trying.

What leverage reduction is significant?

The retail clients and brokers are not overly sensitive to moderate leverage changes. A client that had previously a 1:500 leverage can accept also a 1:200 to 1:300 leverage if he has already a long-term relationship with the broker and in general likes the service quality. Chances are that since he will expose himself to less risks, his life-cycle and thus time to gain more experience will be longer. Thus the probability of the client becoming successful goes up. All parties win.

A key term useful to point out here is „long-term relationship“. Clients become sticky (loyal) the better the service and the longer the relationship with the broker. The brokers that have offered so far high deposit bonuses, have huge marketing budgets or are just greedy have had to provide inferior service quality (i.e. wider spreads, slower execution, higher commissions, slower speed of processing withdrawals, smaller product offering, etc). With such a service they have not been able to build a long-term loyal client base.

We all know also that in the regulated markets bonuses have already been banned recently so the main incentive for these clients to stay with these brokers is gone. This is something that has already hit hard the regulated binary options brokers. What will happen now when the maximum allowed leverage will be gradually reduced in Europe on all FX and CFD products?

My assumption is that should the maximum leverage in Europe be reduced to the range of 1:200 to 1:300 then the larger FX and CFD brokers with a good service quality and a strong capital base will actually get more business over the coming years which will not only make up for the short-term reduction in revenues due to lower leverage but they will probably even become bigger than they are today.

Look for brokers that have good reputation with strong capital base today and you will be safe with them as a client, as an employee or as a business partner. The above leverage scenario is a win-win-win situation. For responsible brokers with long-term business perspective, for clients who would have longer life cycle with less risks and also for regulators because only strong and fully compliant brokers will stay in the business. The bottom line is that over the coming years we will see the retail FX and CFD brokerage industry becoming much more mature with lesser players.

Now, should the European regulators, especially keeping in mind the UK FCA, lower the maximum allowed leverage for retail clients to the range of 1:50 to 1:100 then 70% to 80% of the existing European smaller and medium-size regulated FX and CFD brokers will go out of the business within the next 12 to 24 months. This is something that the regulators have to keep in mind because there is a significant monetary risk also for the end clients the regulators are trying to protect because sudden shifts in leverage will have sudden impact on the profitability of all market participants of which some might face solvency issues. In my mind this is the most overlooked risk by the EU regulators primarily in some of the European markets where there is a high concentration of brokers and thus clients. In my last article I already wrote about increasing number of brokers coming to the M&A market to sell themselves outright or to find strategic investors. This process has intensified during the last few weeks.

I would recommend everybody to take a look at what happened in Poland after July 2015 when the maximum allowed leverage was reduced from 1:500 to 1:100. Some of the local brokers decided to exit the industry while the remaining Polish brokers saw massive reduction in revenues. Some of this data is publicly available. A lot of the Polish clients have now shifted from Polish brokers to offshore brokers.

Should the 1:50 to 1:100 maximum leverage scenario realize in Europe then it would be wise to look for brokers that have currently significant non-European business and that either already are or intend to agressively diversify into the non-FX products. Also I believe the larger well-capitalized European players should do well although some cost-cutting might be needed to adjust with lower short-term revenues.

It’s really hard to imagine that a lot of the plain vanilla FX brokers would be able to diversify into offering products such as stocks, futures, options as these instruments are traded by people who have completely different profile compared to the ordinary FX traders. These guys look for completely different service approach in terms of sales, marketing, customer support and of course physical presence in their home country.

Stay tuned for more and trade with Tickmill!

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