FSCA continues its clean-up of the online broking industry

The Financial Sector Conduct Authority (FSCA) has recently announced that it is investigating Nirvesh Financial Services Proprietary Limited (Nirvesh Financial Services) and Veracity Markets Proprietary Limited (Veracity Markets) for allegedly conducting unauthorised over-the-counter (OTC) derivative business and possible breaches of other financial sector laws.

Since 2018, the online broking industry has been plagued with uncertainty and misunderstanding following the publication of the regulations under the Financial Markets Act, 2012 (FMA Regulations).  After years of contracts for difference (CFDs) being unregulated, the FMA Regulations gave existing online brokers offering CFDs until June 2019 to apply for their over-the-counter derivative provider (ODP) authorisation in order to continue operating.

CFDs are a form of financial derivative, allowing the investor to obtain exposure to the price movements of an underlying asset without actually owning it.

The FSCA has directed Nirvesh Financial Services and Veracity Markets to immediately cease acting, advertising and holding themselves out as ODPs; to immediately cease any new OTC derivative business; to close all open OTC derivative trading positions of their clients; and to pay out to clients all funds owing to them.

Nirvesh Financial Services is a Category I financial services provider, authorised to provide advisory and intermediary services in respect of derivative instruments, in terms of the Financial Advisory and Intermediary Services Act, 2002 (FAIS).  Veracity Markets is a juristic representative of Nirvesh Financial Services,  allowing Veracity Markets to act pursuant to the Category I authorisation of Nirvesh Financial Services.

Veracity Markets describes itself as an “execution-only trading intermediary” and notes that it makes use of regulated liquidity providers for the clearing of its client trades.  While it is not entirely clear what an “execution only trading intermediary” means in this context, it is important to distinguish the services that can be performed under a FAIS authorisation and those that require authorisation as an ODP.

The FSCA announced its investigation on the basis that neither Nirvesh Financial Services nor Veracity Markets have the necessary ODP authorisation to offer trading in CFDs.

An ODP is described in the FMA Regulations as a person who, as a regular feature of its business and transacting as principal, originates, issues, sells or makes a market in OTC derivatives.  A person may not act as, advertise or hold itself out as an ODP where they are not appropriately authorised by the FSCA.

There is often a misunderstanding between the ODP and FAIS regimes.  The ODP regime regulates the principal activities conducted by ODPs.  Where an entity issues, sells, makes a market or originates OTC derivative transactions in South Africa, such entity would require an ODP license.  On the other hand, FAIS regulates advisory and intermediary services.  Where an entity markets the products or services of an ODP, such marketing activities would be considered as intermediary services and require an authorisation under FAIS.

Accordingly, different services are regulated under the two regimes.  The providing of principal services in respect of OTC derivatives will require an ODP authorisation, while the marketing of such OTC derivatives by a third party as an intermediary for a product supplier, will require a FAIS authorisation.

For an entity to market or promote (Referring Broker) the OTC derivatives issued or sold by a different provider, it would require a Category I authorisation in terms of FAIS, with “derivative instruments” listed as a category of financial product for which it is authorised.  The Referring Broker would only bring itself within the ODP regime where it either enters into the CFDs itself as principal or promotes its own OTC derivatives contracts as principal in South Africa.

The relevant issuer of the OTC derivatives (being promoted by the Referring Broker) would require an ODP authorisation should such OTC derivatives be issued or sold in South Africa. The fact that such issuer may only act pursuant to so called “straight through processing”, i.e. all trades are passed on or hedged with a different liquidity provider, does not remove the need for such issuer to be authorised as an ODP.  This position may be different if the local entity only acts as a Referring Broker and does not issue any OTC derivative contracts in South Africa.  In such circumstances it may only require a FAIS authorisation.

It is important to distinguish the FAIS regime from the ODP regime.  The introduction of the ODP regime has resulted in previously unregulated activities now being regulated.  Brokers operating within the derivatives market should not assume that their FAIS authorisation is sufficient for their current activities.

This article has been co-authored by Shawn Barnett (director) and Hishaam Khan (associate designate) of Norton Rose Fulbright South Africa Inc.

First published by: Financial Institutions Legal Snapshot