Czech Regulator Suggests Prop Firms "May Be Subject to Potential MiFID Regulation"

Czech Banking Regulator Stirs the Pot

The Czech National Bank told foreign media (Finance Magnates): "The business models used by companies engaged in prop trading can take various forms, some of which may fall under the MiFID (Markets in Financial Instruments Directive) regulatory framework."

In this context, it's worth noting that one of the top prop firms, FTMO, is based in the Czech Republic.

The Czech National Bank stated: "We believe relevant MiFID services could include receiving and transmitting orders related to one or more financial instruments, such as executing client orders or trading on one's own account."

"However, in other cases, MiFID exemptions may apply, meaning prop trading entities are not regulated by the Czech National Bank and do not require regulation. Additionally, we emphasize that any fraudulent behavior would be subject to criminal law sanctions."

The Czech National Bank said it has "taken note of the prop trading industry" and is "well aware of the prop trading phenomenon's existence and occurrence," believing that "potential new regulations in this area need to be evaluated at the EU level."

Furthermore, according to Remonda Kirketerp-Møller, founder and CEO of Muinmos, "Regulators have been conducting research, collecting data, and consulting with industry participants to better understand the nature and impact of prop trading."

However, no top-tier regulator has confirmed they will push for prop trading regulation, making the Czech National Bank the first in the EU to comment on prop trading regulation.

No Regulation Needed? Or the Same Rules as Forex CFDs?

Greg Rubin, head of prop firm Axi Select, believes that "prop firms should be subject to the same rules and scrutiny as forex CFD brokers."

Meanwhile, Matus Tutko, General Legal Counsel at another prop firm, FTMO, argues that regulation is unnecessary because "the current regulatory environment is already sufficiently robust." By "current regulatory environment," Tutko refers to general business rules such as "consumer protection rules, data protection rules, international sanctions rules, and other laws."

FTMO's General Legal Counsel stated, "I truly believe there are good reasons why the modern prop trading industry shouldn't be subject to any specific regulation. Clients are only trading on demo accounts and never deposit any funds for actual trading, so they face no risk of losing money." However, he also supports "self-regulation to achieve compliance and enhance customer trust."

Axi's Rubin holds the opposite view, explaining in detail that "prop firms ultimately serve retail traders with profit ambitions. I don't see how this differs from the standard forex CFD industry, which we know is strictly regulated."

Rubin states, "It seems the main reason the industry has avoided regulation so far is the technicality of using demo accounts instead of real trading accounts. This means it's virtual, with no 'real trading' or financial transactions occurring. When you dissect these technical details, you'll find that the behavior in prop challenges is very similar to trading CFDs with a broker."

Ran Strauss, CEO of Leverate, also believes that "prop firms will ultimately be required to comply with the same standards of regulation and transparency we currently see in the CFD industry."

Although most believe the time has come, Quinn Perrott, Co-CEO of TRAction, thinks that "there are more pressing regulatory demands for major regulators. If brokers use account structures similar to prop firms to circumvent local bans on retail client CFD trading or specific CFD requirements, that would be an issue worth addressing."

Should Prop Trading Regulation Apply New Rules or Old Frameworks?

Although regulators have not yet formally announced their plans for prop trading regulation, the question remains: Will there be a new set of rules, or will prop trading terms be incorporated into existing broker rules?

Evdokia Pitsillidou, Head of Risk and Compliance at SALVUS Funds, believes "both approaches could be considered to effectively regulate prop trading. Not only can the existing regulatory framework for financial service companies, such as OTC retail brokers, be strengthened to accommodate prop trading activities. Enhancing the current regulatory framework would involve updating regulations to address the specific needs of prop firms and their clients."

"At the same time, new rules specifically targeting prop trading companies could be introduced. These rules would be designed based on the unique characteristics of prop trading, including the types of services offered, the nature of the clients served, and the complexity of the trading strategies adopted."

Most experts Finance Magnates spoke with agree on a hybrid approach rather than entirely new regulatory rules.

Eden Lang and Ariel Yosefi, partners at Herzog Law, also state, "Although prop trading has unique characteristics, these differences are not sufficient to require entirely new legislation or any different regulatory oversight. This approach leverages the existing regulatory foundation while adjusting for the unique risks and opportunities presented by prop trading, such as relaxing licensing and minimum capital requirements."

Potential Future Regulation of Prop Trading Firms

Prop trading firms allow retail traders to trade using the company's funds and share a portion of the profits with them. However, traders need to prove their skills through trading challenges, and most challenges, even funded account trading, are conducted in a simulated environment.

As registered businesses, prop trading firms are not required to publish any business data that brokers must disclose.

Evgeny Sorokin, CEO of Devexperts, states, "The biggest issue is the rules for determining whether a challenge is passed or failed. There's a lot of room for manipulation in this area. Companies have a financial interest in not wanting traders to pass challenges, and many trading rules are 'not clearly defined but based on the prop firm's discretion.'"

The transparency of challenge success rates is indeed an area regulators could focus on. This is very similar to retail forex and CFD regulation, as many top-tier regulators require brokers to display the percentage of losing clients.

Ran Strauss, CEO of Leverate, says, "We expect the same regulation and transparency as CFD companies, for example, disclosing and displaying the percentage of successful challenges, the comparison of payouts to income, where their liquidity comes from, etc."

If traders successfully complete trading challenges, they often face payout challenges. Some prop trading brands, such as The Funded Trader, Skilled Funded Traders, and many others, suddenly stopped payouts, leading to numerous customer complaints on social media forums. Although The Funded Trader promised to fulfill its payment obligations, Skilled Funded Trader is still not operating and has yet to make a public statement.

Sorokin also states, "Determining the industry structure and safeguarding payouts if prop firms face financial difficulties is another important area. This can be achieved by requiring prop firms to separate payouts from other parts of their business. There are also a series of other rules regarding payouts that companies need to follow, ensuring payments are made within the promised timeframe."

TRAction's Perrott believes "suitability tests would be a good start for prop trading regulation, along with transparency in pricing provided to clients, which is the basis for evaluating their performance, and full disclosure of account structures, whether trading on real funds or synthetic accounts (demo accounts)" is another area regulators must focus on.

Justin Hertzberg, CEO of FPFX Tech, believes industry regulation should include the following points:

Background, competency, and financial reviews of prop firm principals

AML/KYC checks on all traders before they obtain funded accounts

Consistent, dynamic net capital requirements as the number and amount of "funded accounts" increase

Disclosure and transparent display of simulated/virtual or real-time trading environments, liquidity sources, counterparties for trade execution, conflicts of interest, deposited assets, pass/fail rates, payout amounts and numbers

Review of marketing materials to ensure clarity, accuracy, and truthfulness

Annual financial and compliance audits

The Future of Prop Firms

Despite the controversy surrounding prop trading, the popularity of such services is only increasing.

Several retail brokers, including ThinkMarkets, OANDA, Hantec Markets, and Blueberry Markets, have launched their prop trading services, with more companies expected to join in the future.

The CEO of Devexperts states, "We will see more and more traditional retail brokers entering this field, which is good for both the industry and traders. These companies are already regulated and operating, so they can be trusted to follow the rules, and if they don't, they have more to lose."

FPFX's Hertzberg adds, "Brokers make the best prop firms because they are typically well-capitalized, led by executives with extensive financial services experience, already operate regulated businesses in multiple jurisdictions, and have most of the infrastructure needed to run such businesses."

Interestingly, FTMO, which has been offering prop trading services since 2015, is now preparing to launch brokerage services. However, considering the number of companies in this emerging industry, it can be said that prop trading will become an independent industry rather than just an auxiliary service for brokerage firms.

Leverate's Strauss says: "The concept of prop trading is great, combining company funds and profit-sharing while also limiting trader risk. This approach isn't a niche product, but it's not suitable for every trader either. Looking ahead, the prop trading market is expected to expand, but to truly thrive, it must operate under appropriate regulation."

Key Points on the Prospective Regulation of Prop Firms

1.Current Status and Trends in Prop Firm Regulation

Czech National Bank first to publicly discuss prop trading regulation
Potential new regulations being evaluated at the EU level
Regulators researching and consulting with industry participants

2.Controversy Surrounding Prop Firm Regulation

Some argue for regulation equal to forex CFD brokers
Others believe existing business rules are sufficient, no additional regulation needed
Debate centers on technical differences between demo and real trading accounts

3.Potential Focus Areas for Prop Firm Regulation

Transparency: Disclosure of success rates, payouts, liquidity sources, etc.
Client Protection: Suitability tests, clear pricing
Financial Regulation: Capital requirements, payout safeguards
Compliance Audits: Background checks, AML/KYC, annual audits
Marketing Standards: Ensuring accuracy, avoiding misleading information

4.Prop Firm Industry Development Trends

Traditional retail brokers entering the prop trading space
Prop trading may evolve into an independent industry rather than just an ancillary brokerage service

5.Future Challenges and Risks for Prop Firms