In the first article from my new series, ‘How to build a brokerage house‘, I reviewed all the essentials you need to know if getting into this line of business. I believe that today’s market is full of untapped opportunities due to a lack of know-how and proper management of the disruptive challenges invading the fintech world. A deeper understanding of these technologies will help you gain new insights in this competitive field, then find a niche where you can grow.
My second article on this topic will cover the licensing part and how to regulate your business.
What is a brokerage license?
The brokerage license allows you to offer online trading services depending on the jurisdiction you choose and the regulatory entity covering the services you want to provide.
So, once you’ve done your homework and feel ready to get started, you can think about the licensing and regulatory side of the business.
Choosing the regulator helps you to:
1. Decide on the type of customers you are targeting
2. Have a clear idea of what services you can offer
3. Prepare the amount of capital you need
4. Establish the company’s organizational chart
Before I get into more details, I will discuss the pros and cons of having a brokerage license.
Pros and cons of a licensed broker
Pros of brokerage license:
Credibility and authority boost
A regulated business gives customers the certainty that you comply with the law and are committed to ethical business practices.
Additional exposure to financial support
Generally, a brokerage license can provide a seamless flow of funds, which, in turn, contributes to business development.
Authenticity and credibility are something you can’t earn overnight. To gain such benefits, a company must work within the letter of the law and maintain compliance without the slightest deviation. Such commitments can even help the business benefit from significant investment from outsiders.
Discourages unfair practices
Virtually every business that holds a brokerage license has an obligation to avoid unethical business practices.
Cons of brokerage license:
Strict financial obligations
Obtaining a brokerage license has certain costs, both to receive and maintain it over time. I will talk about this later in the article.
Ongoing monitoring and verification
If you become a licensed broker, you should expect frequent visits from the regulated authorities to ensure the smooth running of the financial markets locally, such as the ASF in Romania.
Lack of flexibility in marketing activities
A brokerage license can limit your creativity in how you promote your online trading products and services.
How does the regulatory and licensing part work?
The world’s major financial markets are constantly under the scrutiny of regulators designated to ensure that their activities comply with legal requirements. For example, the Financial Industry Regulatory Authority (FINRA) is responsible for the smooth running of capital markets in the United States. At the same time, for Europe, we have the European Securities and Markets Authority (ESMA). Going even further, we have different regulators at the local level – BaFin in Germany, CNMV in Spain, CONSOB in Italy, and HCMC in Greece are just a few examples.
Next, I will focus on the licensing side of the European market, as this is my forte in knowledge and expertise.
Brokerage Licensing in Europe – CySEC
The Cyprus Securities Exchange Commission, known as CySEC, is the regulatory body for the financial industry in Cyprus. Its mission is to ensure the protection of investors and the prosperous growth of the securities market. As soon as Cyprus became a member state of the European Union (2004), CySEC’s regulations and operations overlapped with the European financial regulatory framework, offering Cyprus-registered companies access to all European markets.
Most companies currently licensed under CySEC are STP brokers or Market Makers offering access to online trading of financial instruments via Contracts for Difference (CFDs). Others handle asset management or investment advice.
STP brokers and Market Makers – what are the differences?
- STP brokers: they send all orders to the market
- Market Maker (MM) brokers: they provide bid and offer quotes for specific financial instruments, which can be viewed and traded by individual clients on the broker’s online platforms; under their risk management mandates, the Market Maker brokers may hold some or all market risks arising from client orders.
How can you set up a CIF (Cyprus Investment Firm)?
According to the Legal Framework, a broker must set into place or outsource the following departments and functions to receive CySEC regulation and access to the rest of the European markets:
- A Cyprus-established firm with local offices
- It must have at least two executive and two non-executive directors
- Management consisting of 2 senior managers (CEO & COO/Managing Director)
- Trading room for receiving and transmitting customer orders and executing orders
- Portfolio management department (if applicable)
- Investment advisory department (if applicable) for providing personal recommendations to clients
- Back Office for opening new accounts and maintaining and updating client files
- Finance and Accounting Department for book-keeping and record-keeping of both CIF and client records
- Marketing and Customer Service departments
- IT department for the protection of the company’s data, network, servers, and personal computers
- Risk Manager for identifying and assessing risks, plus designing and implementing risk strategies or procedures
- Compliance Officer responsible for the compliance of investment services and activities with the CIF’s legal obligations
- Internal auditor to ensure that the operations manual is up to date with the provisions of both internal processes/procedures and external legal obligations
- Anti-Money Laundering Compliance Officer
The licensing process can take up to 6 months.
What are the minimum capital requirements?
Depending on the investment services and the type of broker you choose, certain minimum capital requirements will apply. The levels are the following:
1. 50.000 € (without holding client funds) or 125.000 € (holding client funds) for STP brokers
The services include reception and transmission of orders, execution of orders on behalf of clients, portfolio management, and investment advice (the last two require a special license).
2. 730.000 € for Market Makers
In addition to the services rendered by STP brokers, Market Makers can also offer underwriting and placement of financial instruments on a firm commitment basis. Your clients will also benefit from the operation of the multilateral trading facility.
What other types of brokerage licenses are there?
ASIC – Australia
FCA Canada – Canada
DFSA – UAE
SFC – Hong Kong
MAS – Singapore
FCA UK – the UK
I will elaborate more on UK licensing.
UK brokerage license
The regulations set by the FCA must be strictly followed by the licensor’s customers and ensure long-term cooperation between the parties.
Licenses for brokerage activities in the UK are issued to firms that fully comply with all UK legislation, have their own office in the UK, and have a certain amount of authorized capital.
The main feature of the UK financial rules is the absence of clear restrictions on the amount available in the company’s bank account: the applicant sets the required level himself, however, a form justifying the amount is added to the pile of documents. Confirmation of the account’s funding level is often necessary together with the other papers.
UK jurisdiction involves and requests the employment of UK residents in senior management positions. All other board representatives must have considerable financial management experience.
The application form, branch information, and local bank accounts are essential for your request to be considered. Obtaining a brokerage license is impossible without registering a legal entity and opening an account.
The brokerage license is issued after a thorough study of documents and tools for operating in the foreign exchange market. The main condition is an authorized capital of €125,000. Another mandatory requirement is the presence of at least 2 local directors (British citizens) in the company structure.
Other types of licenses – EMI and neobanking
- An EMI (Electronic Money Institution) license allows an e-money institution to operate. An EMI license can open many opportunities, such as expanding your business worldwide by opening IBAN, SWIFT, and SEPA accounts and offering your own payment cards.
- Early summer of 2018, the Romanian government took emergency measures in e-money regulation and EMI activities in the country.
- Here are some of the provisions that came into force:
- authorized capital of 350,000 euros;
- BNR (the National state bank) must approve the company’s management
- credit structures, legal entity-issuers, and postal service providers releasing e-money may be allowed to operate according to the rules of national and European regulators;
- a clear administrative system for organizing the issuing of electronic funds;
- the business can start within 12 months of receiving regulatory authorization (RNB);
- an audit once a year – with the report received and submitted to the RNB (acting as supervisory authority);
- evidence of reasonable management, a well-established e-money issuance process, a clear organizational structure, and developed risk control procedures;
Neobanks are 100% online banks that use digital channels to serve customers. Unlike traditional banks, neobanks do not have physical branches, and everything is done through digital services.
Typically, a company can offer neobanking services in two ways:
- By obtaining an EMI license enabling digital payment services, including the creation of IBANs, as well as the release of e-money (BIN sponsorship – credit card) and managing it, allowing the end-user to keep funds in the account.
- Through a Payment Institution (PI) license, which supports a wide variety of payment services allowing transactions to be made by card, mobile app, transfer, or direct debit. PI also supports cash withdrawals, account deposits, foreign exchange transactions, and data processing.
Obtaining a brokerage license involves strict rules, significant capital requirements, and time to devote to the process. A brokerage firm can provide a good return on investment if you learn to play your cards right. Not everyone in this industry can launch a successful business. Hard & soft skills could be a plus, as well as generous investment capital and a high capacity to adapt to industry changes. I will talk about all these points and more in the next parts of the series, hoping it will help you set up an online trading company.
You can follow me on Twitter and LinkedIn!