JP Markets and their “Toxic Clients”: The FSCA Shows its Teeth

The sudden downfall of JP Markets is still sending reverberations through the wider Forex industry in South Africa. The subject of numerous complaints over the years, the FSCA’s decision to suspend JP Markets licence was not surprising, though it still came as a shock to an industry that has become accustomed to light-touch regulation over the last decade.

That the FSCA is acting against bad brokers is very welcome, the Forex industry in South Africa has been battered in recent years by waves of Forex scams. While the FSCA has shown its competence in prosecuting individual fraudsters and conmen, it will come as a relief for many that trading with an FSCA-regulated Forex broker now implies genuine consumer protection.

Now the subject of a winding-up order, JP Markets are fighting for their life. The FSCA has compiled the most serious complaints and presented them to the high court. Most complaints detail a pattern of withholding client withdrawals or not posting deposits to client trading accounts, themselves egregious wrongdoings – especially as Forex brokers live or die based on their reputation for fast and fair funding transactions. But some of the complaints are more technical and more damning.

“Toxic Clients” and Market Makers

What started as a routine investigation into missing and slow client withdrawals was blown open when the FSCA interviewed Saad Sidat, an industry veteran and former employee of JP Markets who allegedly managed their trading operations. He shared emails from the owner and CEO of JP Markets, Justin Paulsen (don’t you love a guy who names a company after themselves), demanding that “toxic clients”, or clients that make large profits, be put into special “group with a higher spread”.

Market data manipulation by brokers is a major transgression in the Forex industry. In Europe and the UK there are specific laws requiring brokers to adhere to best execution standards. The EU’s MiFID II rules explicitly state that brokers must “take all sufficient steps to obtain, when executing orders, the best possible result for their clients taking into account price, costs, speed, likelihood of execution and settlement, size, nature or any other consideration relevant to the execution of the order”.

Back in South Africa, the FSCA recently drafted a new set of rules for exchanges, which includes a best execution directive, but this is not currently law. But even if best execution is not enshrined in law, data manipulation to push clients into a losing position is still fraud. It is just a lot harder to detect.

The problem here is that JP Markets is a market maker broker, as are most Forex brokers. Market maker brokers always act as counterparty to every trade, i.e. when a trader loses money on a market maker’s platform, the market maker profits, and vice versa. While this does create an inherent conflict of interest, market maker brokers are an essential part of every market. They provide much needed liquidity and opportunity for traders with less means. Well-regulated market makers are the backbone of the Forex industry worldwide.

Market maker brokers, as the name suggest, do not post client trades to a market, but behave as the market themselves. While this does increase risk and requires a market maker to have substantial liquidity, it also means that they can alter the spread as they see fit. So, JP Markets can widen the spread between on a currency pair as much they want, but is it fraud?

Stupid, but maybe not Fraudulent,

Even if it is not fraud, it is certainly not clever. When altering the spread in such a radical fashion, even for a small group of “toxic clients”, JP Markets opens itself up to arbitrage. Forex arbitrage is when traders take advantage of the difference in spreads between JP Markets and another, less manipulative, broker. By selling a currency pair on JP Markets and buying it on another broker’s exchange, a trader can almost guarantee a profit in extreme cases.

This is interesting, because this is what may have to led to these so-called “toxic clients” making large profits to begin with. By further pursuing these clients with wider spreads, JP Markets was only opening itself to an even great risk of arbitrage.

Whether these clients were using arbitrage or not remains to be seen, what we can say is that JP Markets senior management discussed manipulating data to force profitable clients into losing positions.

The FSCA and the OTC Market

As a result of Sidat’s evidence (which Paulsen says is driven by bad blood over a breakdown in their relationship), the FSCA has filed an urgent application to the high court for the liquidation of JP Markets. The FSCA has further accused JP Markets of mixing client funds and operational funds in the same accounts (another serious infraction) and forcing clients into losses by interrupting their trading platform, among other things.

One of the FSCA’s filings has stood out though, they have also accused JP Markets of operating without a correct licence. JP Markets has held a category one derivative licence since 2016, allowing them to offer non-automated advice and act as an intermediary in the case of derivative trading. All online Forex trading is over the counter (OTC) derivative trading and all Forex brokers based in South Africa hold this licence.

But, the FSCA has recently began a drive to move all OTC derivative brokers on to a new form of licence, knows as the ODP (Over-the-counter Derivative Provider) licence. This drive has been hit with delays and no measure of uncertainty from the industry and many Forex brokers are still waiting to apply for one until they have a clearer picture of what the requirements are and what the FSCA’s role will be.

In a recent interview on the JP Markets scandal, Gerhard van Deventer, the FSCA’s head of investigations, stated that: “For an operation like JP Markets to actually be the issuer/counter-party to the CFD is illegal, unless it holds an over-the-counter derivative product provider licence issued by the FSCA. Such a licence will enable an entity to issue CFDs and other derivatives, but it will only be issued to applicants that can pass the stringent requirements put in place to protect clients… These requirements inter alia relate to managing the massive risk associated with being an issuer of a geared product like a CFD. There is also the problem of the self-evident conflict of interest that exists in this situation.”

What is clear here is that the FSCA has begun to take a more active role in regulating the Forex industry in South Africa, and that they are willing to use their teeth when they can. The FSCA also seems to be attaching much greater importance to the new ODP licence than many Forex brokers may have expected. Those brokers that have not yet applied for the licence, especially other market makers, are probably watching the JP Markets case nervously.