Who’s executing your future trades? Your brokerage firm may be unregulated. This may be totally lawful. You should still care.

Regulators don’t seem to agree about executing brokers. Some regulators – like the UK’s Financial Conduct Authority – want shiny gold-plated compliance regardless if the broker is executing an off-exchange block trade or listed futures directly on the exchange. The UK’s FCA expects the licenses in place, the brokers to be appropriately regulated and all the good things that flow from there: best execution, investor protection and sustaining the integrity of the price formation process.

Meanwhile, the Swiss regulator, FINMA, is hands off if the executing broker isn’t holding client funds and you’ll find executing brokers in Switzerland largely outside of FINMA’s jurisdiction. A brokerage firm can execute not just off-exchange blocks but also on-exchange futures without a regulatory license.

Theoretically, an execution-only brokerage which doesn’t hold client funds and operates in Switzerland can hire an employee to broker listed products even if that individual is banned from executing futures in the UK. After all, the Swiss brokerage may not require licensing either as an entity or for its employees.

In Singapore, MAS requires an executing brokerage to apply for an exemption from licensing for block trades. Want to execute listed futures in Singapore? You need the whole shebang, gold plating, no exemption available. But the capital requirements for a license in Singapore are steep which means many executing brokers stick to blocks and the light compliance rules that follow from operating under an exemption rather than a regulatory license.

But what if you’re a UK trader dealing with an executing broker in Singapore or Switzerland? Will the UK regulator offer you protection? If your broker is based in Singapore or Switzerland there’s a good chance the trade and broker will fall outside the FCA’s jurisdiction.

You want to pull that recorded call log to show your broker executed at the wrong price or volume? That may be tough luck if your broker, unbound by any regulatory requirements, doesn’t keep recordings. If you still want to trade through an unregulated brokerage firm, you may want to consider incorporating requirements such as record keeping into a brokerage contract and construct a contractual compliance framework where the external regulatory framework is absent.

What about the US? Well, like the UK regulators, the US CFTC likes brokerage firms which execute futures products to be licensed. Executing brokers need to be licensed by the National Futures Association, which is an industry self-regulatory organisation but has authority from the CFTC to take disciplinary action against any member that violates its rules. Doesn’t matter whether the brokerage executes on-exchange listed futures or only off-exchange block trades – it needs to be appropriately licensed by the NFA unless the customer and the exchange is outside the US. Actually, even if your brokerage isn’t based in the US, it likely needs to be licensed by the NFA if it deals with US customers.

Don’t assume if the parent or one of the subsidiary companies falling under an umbrella of related brokerage companies is regulated all the brokerage companies in that group are regulated. Don’t assume the regulators want the same thing or offer the same protection. Even if you’ve traded a particular product with a regulated brokerage firm, if you’re now facing a separate but related company in a different jurisdiction, that company may be operating in a completely unregulated space.

But why care if a brokerage firm is regulated?

Something go wrong with the transaction? A regulator may not have jurisdiction.

Plus your transaction may have higher odds of going wrong.  After all, an unregulated brokerage firm isn’t bound by regulation requiring best execution. It doesn’t need to run background checks on its brokers or even to train them to go for anything other than your $s.

Want to keep up with developments in the regulatory space or find out more about your particular regulatory requirements? Email ruth@zeilbergerstone.com.