ESMA is mad about copy trading

In theory, copy trading is one of the more interesting parts of the retail trading sector. Some random person has the ability to raise capital and manage money, much like a genuine fund manager but with significantly lower barriers to entry.

In practice it has become, at least for many brokers, just another marketing tool and means by which to onboard clients. The trouble is that many brokers clearly aren’t meeting the standards necessary to provide these services.

This was made apparent by a recent supervisory briefing that the European Securities and Markets Authority (ESMA) released at the end of last month. Like most regulatory documents, it’s a scintillating read and I recommend having a look at the paper yourself.

For those feeling uninclined to do so, It looks at different types of copy trading and what regulatory standards companies offering the service have to adhere to. With regard to the latter, the key point is that a copy trading service where the client’s trades are automatically executed requires portfolio management licensing. 

Most brokers do not have this and so outsource it to a third-party. In the UK, Pelican has become a popular method by which to do so. Brokers make a partnership with Pelican and are then able to offer copy trading services. Others have their own in-house offering or use other providers.

One of the points ESMA makes is that brokers have to actually acknowledge that these sorts of partnerships exist. But if you look at some providers, there is close to zero recognition that they do. Of course, were things to go wrong, then it seems very likely the broker will tell their client, ‘sorry bro, we’re just an execution platform, please go speak to company X, which is the investment manager that provided you with the service’.

The thing is this arguably applies to the majority of the points that ESMA makes in the document. For instance, companies have to make sure clients have a certain risk profile. They then have to take steps to make sure the trades they are copying stay within that risk profile. There is simply no way some brokers are doing this. 

Even basic things like appropriateness checks or performance data don’t really hold up to the required standards. This is probably why ESMA went out of its way to release the document.

One way around these problems is, as is often the case, to just go offshore. Many providers appear to have done this and have blocked access to UK clients.

We hope to look at this in more detail soon. In the meantime, you can probably expect the regulator to say, ‘hey, this is what you should be doing’. And the brokers will acknowledge that and then not really do anything.

IG Group buys Small Exchange (again)

When IG Group bought tastytrade in 2021, one of the consequences was that it ended up holding a stake in a couple of other firms. One was Zero Hash, a crypto company that everyone uses but no one actually knows what it does. IG still owns about 10% of Zero Hash, with Interactive Brokers also holding a third of the business.

The other company was Small Exchange, a derivatives exchange based in Chicago. Small Exchange was set up by Donnie Roberts in 2019. Roberts was previously a senior executive at Thinkorswim, a company that the founders of tastytrade set up in the early 2000s and subsequently sold to TD Ameritrade.

Small Exchange had backing from Tom Sosnoff, one of the tastytrade founders, which explains why IG ended up owning close to 40% of the company when it acquired Sosnoff’s options trading firm.

Anyway, if you managed to follow all of that, IG then sold its stake in the Small Exchange, along with its binary options ‘exchange’ Nadex, to Crypto.com – a company active in the ponzi scheme business – in March 2022. That deal was worth $216m.

Now a year later, IG has bought the Small Exchange back. We reached out to IG to figure out what their plans are here. Alas, their PR people are playing their cards close to the chest. Nonetheless, we can try to be like Sean Connery in that movie based on the Umberto Eco book and try to draw some rough conclusions.

On a ‘meta’ level, I have been saying for a while now that exchange-traded derivatives are a ‘thing’ that brokers want to add. This fits with that pattern as the Small Exchange is effectively designed for retail trader-focused products. 

As the name hints at, the exchange lets traders access futures with substantially smaller notional values than their peers. It’s worth noting that CME Group has also been very active in this regard by creating much smaller contract sizes for the retail market.

So you could argue this will end up being more of a B2B play. Market makers and brokers will use the exchange (Tickmill, StoneX, Interactive Brokers and a few others already do) and make them money. At the same time, it’s plausible there could be cost cutting for IG. If they get lots of their flow on to their own exchange, that presumably means paying less money to others.

But then all of this was probably in play a year ago, when they already controlled a lot of the company. So what changed? With this it’s harder to say but if you look at the website, it’s clear Crypto.com did almost nothing with the company. At the same time, the crypto market is totally dead, so maybe they became forced sellers. Given no terms of the deal were publicised, it’s probably IG bought it back for less than they paid.