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One of the things with prop is that you look at all the ads you get for it and how much it’s being spammed everywhere and you wonder, how is this still not being regulated?
Over the last couple of months, I’ve learnt that the FCA, ASIC, and MAS are all confirmed as looking at the sector. At least one large prop has sat down directly with one of these regulators to discuss their business model and operations.
This leads to the next question of why they haven’t done anything. There are probably three things happening.
One is simply time and apathy. If you look at crypto, regulations have only really come into play in a meaningful way in the last couple of years, even though bitcoin ‘came out’ in 2009. It takes a while for regulators to do stuff. Props are no different.
The other factor is logistical. How do you regulate something that does not really fit within any existing framework and where no ‘real’ money is being traded?
For example, let’s say you make simulated trading a regulated activity. What if you are a bank’s compliance team, running a stress test using simulated derivatives trades. Is that now regulated activity in and of itself?
Alternatively, imagine you are a broker or any financial institution offering a demo account or any kind of simulated educational materials. Would that then be covered by these new rules?
Another way of doing this might be to regulate education, which is what most prop firms purport to provide, particularly for their banking and payments providers.
Again, there are clear problems here. You cannot easily regulate financial education, as the ongoing ‘success’ of many UK educators illustrates. There would also (again) be huge indirect consequences. All market analysis by brokers, for example, would become a regulated activity if education was covered by these rule changes.
The basic point is that, as it stands, regulating prop firms is not an easy thing to do, mainly because of the knock on effects doing so would have. I also wonder if they look at it, shake their heads in despair, and then thank God that they’re not having to oversee the activities of these companies.
The third and final point is more of a ‘conspiratorial’ one. A couple of industry executives that I have spoken to claim that, after the My Forex Funds debacle, regulators are being extremely careful about who they go after.
Basically they want to make sure they have a case absolutely in the bag before taking any actions. That makes sense but also seems to be based on hearsay.
It also kind of contradicts the idea that this is unregulated activity. If this is not regulated, how can the regulator go after them?
In the US, with My Forex Funds, the problem seems to have been with offering CFDs in a way that could have been construed as ‘live’ accounts. A lot of props have switched to only doing futures in the US as a result and emphasise repeatedly that it’s all simulated.
Does this mean no regulation will happen? No. But it will probably take a while and it will be interesting to see how it gets enacted. Given the model, it’s possible gaming laws would be more appropriate.
What happens if there are regulations?
A couple of months ago, I met a few people that run one prop. This is not one of the biggest, but it’s definitely a decent sized company in revenue terms.
At a certain point, I asked something like…
“Where is the rest of your team?”
It turned out they only had about five other people working for them. This is one of the weird features of props. They are basically advanced e-commerce businesses and the result is that running a prop requires fewer people than a brokerage does.
However, that is also likely to be a necessity given the economics of the business. We have looked before at payout ratios.
The stats here vary but from what I hear it’s somewhere between 30% to 50%.
This is a lot!
Most props offer affiliates 15% of the account challenge fee. If you are doing paid ads, the average seems to be an acquisition cost of about 10%.
Then you have psp costs (5%), technology costs (pricey), and other activities, like branding campaigns, banking costs, offices, your staff, and so on.
When you add these up, the margins in this business get smaller and smaller.
Now imagine a regulator does step in and it removes 5% to 10% from your total revenues. It’s hard not to see a bunch of props going out of business if that happens.
