Update on the CFD industry in South Africa
Last month, almost exactly a year after it pulled out of the UK and European retail market, Exness launched its South African operations with great fanfare, including a write-up in this esteemed publication. While on the face of it the launch was a great success, behind the scenes the local Forex industry is more wary. As an executive at an established South African broker said - with a touch of cynicism - "yes, it's a big splash... let's see how they do."
The cynicism is well-warranted. The last several years have been tumultuous ones for South Africa's Forex industry. Radical changes in regulation, both locally and internationally, have resulted in greater competition and a more complex supervisory environment; massive scams have shaken the foundations of the industry, creating a wary and deeply cynical customer base; the South African economy has foundered, overcome by decades of governmental mismanagement; and, like everywhere else, the Covid-19 pandemic has turned business conditions on their head.
But South Africa is turning a corner, or so many South African Forex brokers believe. It may be that some brokers do not make it around that corner - but those that do will benefit greatly from a healthier and more egalitarian market.
It is hard to pinpoint the start of this turbulent period for South Africa, but a good place is early 2018, when the European Securities and Markets Authority (ESMA) introduced tight restrictions on the retail CFD market in Europe. This kicked off a period of aggressive expansion by European brokers into developing markets around the world. As a result, the CFD market in Africa has experienced massive growth in the past three years, bolstered by huge marketing campaigns and teams of agents working the towns and villages across the continent. Exness is just the latest in a series of big brokers with deep pockets to be tempted by South Africa's combination of sophistication and relatively liberal regulatory policy.
Meanwhile, the South African regulator (the Financial Services Conduct Authority or FSCA) has been putting the finishing touches to a new regulatory standard for CFD trading.
As a response to the financial crash in 2008, the G20 agreed to apply tighter regulation to derivative trading, widely blamed for instigating the global financial crisis. As a member of the G20, South Africa had been working on regulating the over-the-counter (OTC) derivatives market for a decade. In 2018, these regulations were promulgated and the criteria for the authorisation of over-the-counter derivatives providers (ODPs) were published.
The new ODP licencing regime 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 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 a heavy responsibility to place on brokers (and a considerable technical challenge for the regulator), it is designed to ensure that brokers treat all clients fairly and do not engage in unprincipled or illegal activity.
Interestingly, the ODP licence covers all derivative providers, whether they are banks, financial services companies or CFD brokers - there is no distinction made at the licencing level. As of yet, no non-banks in South Africa have been given an ODP Licence though many have applied and most brokers have found the application process challenging.
In a move that shocked the local industry the FSCA rejected IG Markets' application for an ODP licence in December 2020. Not only is IG Markets one of the largest brokers in the world, but it is also currently licenced by every major regulator in the world. Needless to say, IG Markets has appealed the decision and the case will find itself in front of a tribunal in due course.
It is generally agreed that while the ODP licence application process is arduous, the benefits of the new regime will be great once it has been fully applied. Immediate advantages should include a level playing field for all and an end to bad brokers deceiving their clients.
The local industry acknowledges those benefits but is still watching the IG Markets case closely. Most South African brokers would be reluctant - for any number of reasons - to take the FSCA to court, so this is seen as a test case; the outcome of the which will set a precedent for both the ODPs and the regulator.
Amidst this regulatory upheaval, the FSCA dropped a second bombshell. JP Markets, a large local broker with a less than salubrious reputation, suddenly had its licence suspended in June 2020. The FSCA followed this up with an urgent application in the High Court to liquidate the company; in early September, the liquidation order was granted, and JP Markets was shuttered. A broker with over 300,000 clients and more than R 258 million (USD 17.3 million) in client funds had been ruthlessly crushed in less than three months.
It seems that JP Markets had been the subject of investigation for some months. Customer complaints regarding its withdrawal process (or lack thereof), which had previously fallen on deaf ears, had started being taken seriously at the FSCA. However, the investigation was blown open when a disgruntled former employee shared a trove of emails detailing sophisticated manipulation of client trading platforms. Armed with this new information, the FSCA used the convenient justification that JP Markets did not have an ODP licence (as previously mentioned, no brokers do) to apply for its liquidation.
The sudden erasure of JP Markets sent shockwaves through an industry which was already coping with the faltering South African economy and the first wave of Covid-19. It is widely agreed that JP Markets was a statement from the FSCA to the local CFD community. It was a bloody scalp that could be nailed to the regulator's door as a warning to other brokers and a sign of its commitment to the general public. Of course, it also had the secondary effect of giving the aura of criminality surrounding the Forex industry in South Africa a massive signal boost.
Whatever the FSCA's secondary motivations, it is a fair assessment to say that as a warning, the annihilation of JP Markets worked. In the months since, brokers have reported a more sceptical and interrogatory approach from customers, both new and old, and accusations of fraud from some customers who suffer heavy losses. It is hard to tell how much this has suppressed growth, coming as it has in the middle of the global pandemic, but anecdotally it is weighing heavy on the minds of potential new customers.
It also came as a massive, but not entirely unwelcome, shock to many CFD providers in South Africa. In years past, conversations with principals at responsible brokers have revealed a weariness at the gap between the FSCA's declared goals and the reality on the ground. The JP Markets scandal showed a regulator that was not afraid to flex its muscle when the situation called for it. A regulator that was not content to rely on desktop audits and internal compliance officers to do its job.
Other factors also point to the FSCA becoming more proactive. The frequency with which the FSCA provides public warnings has increased by more than 170% in 2021; the way it has handled IG Markets - the wealthiest broker in Europe and a constituent of the FTSE 250 Index - has shown a willingness to take on the powerful. When combined with the serious approach it is taking to the ODP licencing regime, many industry veterans are aware that the FSCA now means business.
It is telling that all the FSCA-regulated brokers approached for comment for this article declined to be quoted. The FSCA's tactics have led to climate of, if not fear, then certainly wariness and a healthy respect for the regulator's authority.
In years past, the implementation of new policy and regulation in South Africa was often a cause for concern, but that is no longer the case. The prevailing sentiment is that while the collapse of JP Markets and the ODP Licence present serious challenges, those who survive this period will be in a better market and in a better position.
So, where to now for the CFD industry and its regulator in South Africa?
The further tightening of regulations around the world - the UK banning crypto CFDs, ASIC copying ESMA's restrictions and ESMA taking a close look at social trading - is a herald of things to come. The market chaos unleashed by WallStreetBets and its zero-commission enablers will only fuel this reactionary approach.
The FSCA often takes its cue from regulators in the UK and Europe and most South African brokers agree that it is a matter of 'when' not 'if' we will see restrictions on leverage and promotions for CFD providers. And once the restrictions do arrive, many of the high leverage/high turnover brokers will probably head for greener pastures.
If the ODP licencing regime is implemented correctly, many of the less ethical brokers in the local market will be forced out of business. This, in turn, should allow for the delicate process of mending the industry's reputation with the public. While this does require the FSCA to remain proactive and firm in carrying out its duty, the signs are good that it is up to the challenge.
If all of this comes to pass, we may be witnessing the end of an era. This could be the moment when South Africa's CFD market loses its 'frontier' moniker and transitions into a healthy and tightly regulated trading environment. Much will depend on how things play out over the next several months.
