ESMA Regulator on Prop Firms: Preliminary Review of Potential New Rules

ESMA's Focus on Prop Firms Not Yet Action

European Securities and Markets Authority (ESMA) 

In recent years, trader fund management companies operating as proprietary trading firms (prop firms) have gained popularity, drawing the attention of regulatory bodies.

The European Securities and Markets Authority (ESMA) recently conducted a preliminary investigation into these prop firms and discussed potential regulatory measures. However, this pan-European regulatory body has declined to confirm any potential regulatory actions.

Remonda Kirketerp-Møller, founder and CEO of regulatory compliance firm Muinmos, confirmed that "Regulators have been conducting research, collecting data, and engaging in discussions with industry professionals to better understand the nature and impact of proprietary trading."

Currently, prop firms are only required to comply with laws such as consumer protection rules, data protection regulations, and international sanctions conditions. These companies are primarily registered in the United States, United Kingdom, United Arab Emirates, and Saint Vincent and the Grenadines, although many are also registered within the European Union.

Kirketerp-Møller added, "Some jurisdictions have already implemented certain regulatory measures or guidelines to oversee proprietary trading activities in their markets." However, comprehensive regulatory measures have yet to be introduced.

Regulatory Approaches

Regulatory interest in prop trading began last year with the lawsuit filed by the U.S. Commodity Futures Trading Commission (CFTC) and its Canadian counterpart against My Forex Funds. However, these actions were limited to the enforcement level.

In March of this year, the Belgian regulatory body, the Financial Services and Markets Authority (FSMA), issued a warning describing proprietary trading as a "Shadow investment game" that is both costly and potentially leads to reckless behavior. It's worth noting, however, that Belgium is the only country in the European Union that prohibits offering Contracts for Difference (CFD) instruments to retail traders.

However, other regulatory bodies have yet to make any public statements regarding prop trading and its potential regulation. The well-known prop firm FTMO has also confirmed that no regulatory body has approached them "to discuss future regulation of the industry."

Typically, regulatory bodies consult with industry professionals when developing rules. Ran Strauss, CEO of financial services technology provider Leverate, stated: "When Israel introduced CFD regulations, Leverate actively participated in the process."

A senior industry insider revealed: "Some regulatory bodies don't believe in this model – prop trading, some want to ban it, while others think this model will naturally disappear. We should have some clear information by the end of this year (2024)."

ESMA also declined to confirm discussions regarding prop trading regulation, stating that ESMA meeting dates and agendas are not publicly disclosed, and therefore they cannot comment.

Nevertheless, many industry insiders are still anticipating regulatory progress for proprietary trading. Evdokia Pitsillidou, Director of Risk and Compliance at SALVUS Funds, stated, "At the European level, it is expected that regulators will introduce requirements for prop firms, including obtaining authorization under the Markets in Financial Instruments Directive (MiFID), which will involve prop trading services."

"This expectation stems from the understanding that certain aspects of prop trading may fall within the scope of such investment services. This could mean that companies would need this qualification to provide services to clients, even including activities such as charging subscription fees for simulated trading. The aim is to ensure that companies are subject to organizational and operational requirements, enhancing transparency and investor protection in the prop trading sector."

The nature of the prop trading model has also raised confusion about which entity should regulate this industry.

Evgeny Sorokin, CEO of Devexperts, emphasized, "Regulation will definitely come, but it's unclear when, how, and by whom. The operating rules for prop firms might be more suitable for gaming and gambling industry regulations rather than financial regulations."

The Regulatory Dilemma of Prop Trading

Prop firms do not handle client trading funds, nor do they provide brokerage services. Therefore, existing regulations for retail over-the-counter derivative brokers do not apply to them. Furthermore, most prop trading activities, from challenge accounts to funded account trading, are conducted on simulated accounts.

Due to the unregulated nature of prop trading businesses, hundreds of brands have emerged in recent years. While some brands have established reputations, many face complaints, primarily centered on refusing to pay traders.

Due to the unregulated nature of prop trading businesses, hundreds of brands have emerged in recent years. While some brands have established reputations, many face complaints, primarily centered on refusing to pay traders.

"This means that most companies may not even conduct the most basic checks on customers, such as anti-money laundering (AML) or know-your-customer (KYC) processes."

Reference: Exclusive: Regulators Conducted Preliminary Reviews on Potential Prop Trading Regulations