FSCA clarifies which trading activities require a licence

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The FSCA, in its Regulatory Actions Report for 2022/23, has clarified the licensing requirements for derivative traders, including traders in crypto derivatives, and mirror trading.

When an ODP licence is required

In February this year, the FSCA announced it had fined online trader Globex360° (Pty) Ltd R50 000 for acting as an over-the-counter derivative provider (ODP) without authorisation.

Globex had a Category I licence and was authorised to provide advice and render intermediary services in respect of, among other things, derivative instruments (CFDs in equities, currencies, indices, and commodities). Globex was not an authorised ODP as envisaged in the ODP Regulations.

Read: FSCA fines Globex for unauthorised ODP activities

The report said the Authority’s decision on whether Globex acted as an intermediary or as seller of CFDs is an important parameter in establishing when an ODP licence is required.

If an FSP operates in such a way that it is fully hedged or conducts “back-to-back trading”, it essentially means that two CFDs are issued – one by the FSP and an identical one between the FSP and the issuer of the CFD that serves as the hedging transaction. It does not matter that the two derivatives are entered into automatically and seamlessly (“straight through processing”), or that the FSP is market neutral.

In these instances, the FSP is operating as a ODP and requires an ODP licence. The intermediary must not be the counter party to the CFD with the client. An intermediary must not be able to amend the terms of the CFD, and the intermediary must have no liability towards the client if the market turns in favour of the client.

If two platforms are involved in the execution chain, it is a strong indication that the FSP is acting as an ODP, the FSCA says.

If an FSP acts as an intermediary to CFDs, the liquidity provider or ODP must be properly licensed to issue CFDs, failing which the FSP will be in breach of section 2 of the FAIS General Code of Conduct (not acting with due care and diligence).

An intermediary to FSPs must also ensure that it is correctly licensed (derivative licence versus forex licence), which will depend on whether the CFD offering is a foreign-currency-denominated investment instrument. Consideration should be given to whether South Africans are investing in a rand-denominated or a foreign-currency-denominated CFD with the CFD product provider.

Master traders must have an FSP licence

Copy trading, also known as mirror trading, has become increasingly popular on CFD trading platforms. In essence, the platforms enable experienced traders to have their transactions copied by clients.

There seems to be an erroneous belief that a copy trader does not require a financial services licence. But the regulatory action taken against Pioneer FX (Pty) Ltd and Quintin Moorcroft in 2022 shows this is not correct, the FSCA says.

Read: FSCA fines Pioneer FX and Quintin Moorcroft R2m

“Trading decisions made by Moorcroft caused trades to be executed on client accounts. The Authority is of the view that Pioneer and Moorcroft acted as a discretionary financial services provider without having the required authorisation to do so,” the FSCA said at the time.

The Financial Service Tribunal dismissed Moorcroft’s application for the R2 million fine and 10-year debarment to be reconsidered.

Read: How the FSCA decides on the size of an administrative penalty

The FSCA says many trading platforms have multi-account managers (MAM) that traders are using to trade on behalf of clients.

The configuration of the master/copy account relationship varies. In its most basic form, master traders simply inform copy traders of their transactions, and the traders elect whether they want to follow the trades. In some instances, copy traders are informed automatically of the master trades. In the more advanced operations, master trades are automatically copied on the copy trader accounts (and no trades are executed on the master account).

Irrespective of how these accounts are configured, the master trader requires an FSP licence, either a Category I licence (advice and/or intermediary services) or a Category II licence (discretionary services), the FSCA says.

Trading in derivative crypto assets

There seems to be some confusion about the requirement for derivative crypto traders to be licenced. Some providers believe a licence is not required to provide financial services in crypto asset derivative instruments (mostly crypto contracts for difference).

The Financial Markets Act (FMA) defines a “derivative instrument” as a financial instrument or contract that creates rights and obligations and whose value depends on or is derived from the value of one or more underlying asset, rate or index, on a measure of economic value, or on a default event.

Therefore, the FSCA says, a crypto derivative has always been a derivative instrument and as such is a security as defined in the FMA; thus, it is a financial product in terms of the FAIS Act. This means that financial services rendered in relation to crypto asset derivatives (or any other derivatives) have always been subject to the FAIS Act.

There are several examples of enforcement action taken by the FSCA based on crypto derivatives trading (before crypto assets were declared a financial product). The most notable example is the Mirror Trading International case.

The FSCA’s declaration of crypto assets as a financial product does not affect financial services rendered in relation to crypto asset derivatives.

FSPs providing financial services in relation to crypto asset derivatives are already subject to the requirements of the FAIS Act and cannot benefit from the temporary exemption from having to be licensed, the FSCA says.