1. Is there a pressing need for regulators to establish regulations specifically tailored to prop trading? 

Given regulators’ objectives namely, investor protection, transparency, and the sustainability of capital markets, it is indeed high time for regulations to be established around proprietary trading. Recent incidents involving US-based clients, payout denials, and scandals highlight the urgent need for regulatory action in this area.  

Additionally, the proliferation of prop trading firms in an unregulated environment poses risks, potentially creating an abusive environment for clients and investors. Regulation is necessary to mitigate these risks, ensure market integrity, and uphold ethical standards within the industry. 

At the current state, numerous prop trading firms are being established as International Business Companies in third countries such as St Lucia, Anguilla, Seychelles or Mauritius.

2. What progress has been made from the regulatory side regarding proprietary trading? 

On a European level, regulators are anticipated to introduce requirements for proprietary trading firms including authorisation under the Markets in Financial Instruments Directive (MiFID) for the investment service of Dealing on Own Account. This expectation stems from the understanding that certain aspects of prop trading may fall within this investment service category.  

This could entail firms needing this designation to offer services to clients, even for activities such as collecting subscriptions for demo trading. The aim is to ensure that firms are subject to organizational and operational requirements, enhancing transparency and investor protection within the prop trading sector. 

Contact us via email at info@salvusfunds.com if you have any questions concerning prop trading; our Regulatory Compliance team stands ready to support you.

3. What initial regulatory measures can be implemented to oversee prop trading, and which particular areas shall regulators prioritize? 

Regulatory steps for proprietary trading shall prioritize several key areas, primarily to ensure investor protection and market integrity. Regulators can press prop trading firms in the following specific areas:   

• Safeguarding of Client Funds and Assets: Implementing measures to protect investor profits and ensure that clients receive the promised returns from the firm’s trading activities. 
• AML/CFT Compliance: Enforcing anti-money laundering and counter-financing of terrorism regulations, including proper handling of funded accounts, tax reporting, transaction monitoring, and management of company funds to prevent illicit activities. 
• Capital and Liquidity Adequacy: Requiring prop trading firms to maintain sufficient capital and liquidity reserves to support their trading activities and manage potential risks effectively. 
• Risk Management: Mandating robust risk management practices to identify, assess, and mitigate exposures faced by the firm, thereby safeguarding against significant financial losses. 
• Remuneration of Funded Traders: Establishing guidelines for the remuneration of funded traders, including entrance fees, performance thresholds, and ongoing performance metrics to maintain eligibility. 

By addressing these areas, regulators can enhance transparency, accountability, and investor protection within the proprietary trading sector, ultimately promoting market confidence and stability.

4. Shall prop trading be subject to existing financial regulations, or is it necessary to establish separate regulatory measures? 

A combination of both approaches could be considered to effectively regulate proprietary trading. The existing regulatory framework for financial services firms, such as Over the Counter (OTC) retail brokers, can be strengthened to accommodate prop trading activities. This enhancement would involve updating regulations to address the unique needs of prop firms and their clients.  

In parallel, new regulations tailored specifically for proprietary trading firms could be introduced. These regulations would be designed based on the distinctive characteristics of prop trading, including the types of services offered, the nature of clientele served, and the complexity of trading strategies employed. Such regulations would ensure that prop firms adhere to stringent obligations that align with their business model and mitigate associated risks effectively.

5. What are the implications of abrupt trading rule changes made by prop trading firms? Is it an area that regulators shall focus on? 

The abrupt trading rule changes implemented by prop trading firms pose significant challenges amidst the evolving regulatory landscape worldwide. One major challenge arises from differing regulations across jurisdictions, such as the US’s prohibition of CFD trading, complicating the ability of brokers to accept US clients. 

Moreover, ensuring compliance with regulatory requirements is paramount for prop firms to maintain operational continuity and client trust. Prop trading firms that are licensed and operate within regulatory frameworks are likely to instil greater confidence in trading technology providers, who seek assurance of regulatory oversight and adherence to standards. 

Regulators must navigate these complexities to foster a regulatory environment that promotes innovation while addressing the unique challenges posed by prop trading rule changes. 

6. What steps can regulators take to address the issue of widespread payout denials within prop trading firms? 

To address rampant payout denials, regulators must prioritize safeguarding client funds and assets through several key measures: 

• Segregation of Client Funds: Mandating the segregation of traders’ profits from the company’s own funds to prevent commingling and ensure that client assets are protected in the event of firm insolvency. 
• Clear Rules and Terms & Conditions: Requiring prop trading firms to establish clear and transparent rules and terms & conditions regarding the award of profits to clients, thereby providing clarity and certainty to clients. 
• Legal Rights of Clients: Establishing legal rights for traders regarding their profits, including mechanisms for clients to claim their entitled profits and seek recourse in the event of payout denials. 
• Information Transparency: Requiring prop trading firms to inform traders promptly and transparently about their profits, ensuring that they are kept informed about the status of their accounts and any profits owed to them. 

Final Thoughts

In our view, the future of prop trading will be influenced by several factors. The introduction of regulatory obligations, such as AML/CFT measures and requirements for safeguarding client funds and product governance, will likely shape the operational landscape for prop trading firms. Compliance with these regulations will become increasingly important, requiring firms to allocate resources towards implementing robust compliance frameworks. 

Additionally, prop trading firms may explore offshore jurisdictions with lighter regulatory obligations as a means to manage regulatory burdens and reduce operational costs. While this may offer certain advantages, such as flexibility in regulatory requirements, firms must carefully consider the potential trade-offs, including reputational risks and limitations on market access. 

Overall, the future of prop trading will be characterized by a balance between regulatory compliance, technological innovation, and strategic decision-making. Firms that proactively adapt to regulatory changes, embrace innovation, and effectively manage risks are likely to thrive in the evolving landscape of prop trading. 

Contact us at info@salvusfunds.com if you have any questions concerning prop trading; our Regulatory Compliance team stands ready to support you

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The information provided in this article is for general information purposes only. You should always seek professional advice suitable to your needs.