FX prop trading firms have had a rough ride of late. Longstanding concerns around the number of traders who actually make any money have been heightened by the recent decision of the Commodity Futures Trading Commission (CFTC) to charge Muhammad Murtuza Kazmi and his entities – including Traders Global and (collectively known as) My Forex Funds – with fraudulently soliciting customers to trade leveraged, margined or financed retail foreign exchange, and leveraged retail commodity transactions.
The CFTC alleges that the firm offered retail customers the opportunity to use Traders Global’s money to trade against third-party liquidity providers, when Traders Global was the counterparty to most customer trades.
David Dombrowsky, chief executive and founder of FX2 Funding, says conflict-of-interest policies and, potentially, restrictions of trading desks acting as prop firms could help ensure separation between counterparties and third-party liquidity providers. Transparency policies and audits would also help, he adds.
Prop firms tend to function in a similar way to a broker, which has the choice between an A-book model, where all client orders are transmitted directly to the liquidity provider, and a B-book model, where the broker operates as a market-maker.
Impractical solution
The only definitive way for a trader to check which model they are engaging with is to get confirmation from the liquidity provider or counterparty, but the sheer volume and frequency of trades makes individual order verification impractical, says Oliver Olejár, chief operating officer at Lux Trading Firm.
Even if the US takes a definitive regulatory step, not all jurisdictions might align with its decision
Oliver Olejár, Lux Trading Firm
“The outcome of the My Forex Funds case could be stricter regulation or even a ban on the practice, particularly in the US,” says Olejár. “However, it is worth noting that even if the US takes a definitive regulatory step, not all jurisdictions might align with its decision.”
Licensing, reporting and capital requirements could improve regulation, but Dombrowsky agrees that international coordination is unlikely.
Martin Najat, co-founder of City Traders Imperium, says that firms could be required to: maintain adequate financial reserves – and so tackle the systemic risk of not being able to pay out to profitable funded traders; reduce their leverage and offer accounts with slower growth potential; and invest more in compliance personnel and systems.
“Heightened regulatory oversight would ensure a regulated and supervised environment,” he says. “However, it might also deter new entrants from stepping into the market, leading to reduced competition. And as existing firms grappled with adhering to these new regulatory norms, their competitive edge might wane.”
An additional complicating factor is that not all prop trading firms have the same business model. The5ers, for example, does not forward trades to a retail broker, but rather operates as a private equity fund with its own assets and its own pool account. Every trader that is classified and allowed to operate on its behalf is put on the pool account, where automated systems manage their risk policies.
While traders can ask their broker for proof of their liquidity providers, The5ers’ founder and chief executive Gil Ben Hur says that most decline to disclose this information, which shows that even highly regulated brokers that serve millions of traders do not have the capacity to prove how they make their trader’s trades into the so-called ‘true’ market.
According to Ben Hur, since traders are not risking their own capital, there is no obvious role for a regulator in his firm’s case.
“The only regulation that I would see as being required here is in the initial phase when traders are being evaluated,” he says. “It is important to ensure prop firms are not selling products that have no prospect of generating revenue for the trader.”
According to FX market information provider EarnForex, data released by My Forex Fund in December 2021 indicated that just 0.072% of traders who enter the first phase of evaluation reach the first pay-out. In May 2022, Lux Trading Firm suggested that only 4% of all prop traders successfully complete their evaluation.
Risk management
But Ben Hur suggests prop trading offers a higher success rate than retail brokerages – and that traders subject to risk management are more consistent.
As long as their risk-management strategies are efficient, they can maintain cash and profit to pay out to the minority of successful traders
David Dombrowsky, FX2 Funding
“Unfortunately, some firms manipulate systems to ensure traders fail to make back their fees in commission, but the concept of helping traders who don’t have sufficient capital of their own to hone their skills is here to stay,” he adds.
FX2 Funding’s Dombrowsky reckons prop trading firms do not need to hide the fact that they make money from failed evaluations. “As long as their risk-management strategies are efficient, they can maintain cash and profit to pay out to the minority of successful traders,” he says. “It is really no different to how brokers work, since most of them do in-house pricing and B-booking.”
Traders’ losses are not a result of prop trading or its specific rules, and success rates mirror that of traditional broker or individual trading. The primary issue is that many traders approach it like gambling, without effective risk management. Offering increased leverage can further amplify traders’ greed and lead them to seek bigger gains with less effort.
That is the view of Lux Trading Firm’s Olejár, who suggests that in a regulated environment, firms targeting this type of trader would find alternative locations.
“It is a recurring cycle,” he says. “First a trading industry is unregulated, and after regulation is introduced those who want to take a lot of risk move offshore to jurisdictions with looser regulations.”
