2013

Last week, two of the United States regulatory bodies made their position clear on the subject of what they perceive as the perils of trading off-exchange binary options, a method of trading which is illegal in the United States.

In doing so, both the Commodity Futures Trading Commission and the Securities and Exchange Commission posted detailed warnings on their respective websites in order to bring their intended message to the attention of American investors, in a national attempt to dissuade American citizens from engaging in off-exchange binary options trading.

It is one part of the regulators’ mandates to point out potential transgressions of law and act in the best interests of potential investors, but in this double-edged sword, both regulators have charged one particular binary options company, Banc de Binary for soliciting clients in the United States which is an offence.

On Exchange or Off The Market?

Quite clearly as a direct result of the regulatory action pending against Banc de Binary, the company is now no longer accepting clients in the jurisdiction. A representative of the company explained to Forex Magnates today that Banc de Binary categorically does not accept clients from the United States. This demonstrates a sharp contrast to its previously aggressive targeting of American clients which resulted in such a high-profile case being brought against the company.

This was perhaps an inevitable event, however with so many binary options brands now competing for market share, and the US leading the way as far as client protection is concerned.

Other regulatory jurisdictions are following closely, the Japanese Financial Services Agency being an example, which has set in place an entire set of procedures to which Japanese binary options firms must adhere. demonstrating that perhaps other jurisdictions may go down this route, with perhaps two potential outcomes.

Either binary options could be forced onto exchanges, whereby it would be mandatory that a trade goes out from the binary options company onto a real exchange to be executed rather than the client simply ‘betting’ against the company’s in-house risk-management desk, or it could see an exodus of binary options firms from the market as entry barriers to such regulated countries would be raised considerably.

The Voice From Within

Zacky Pickholtz, CEO of recently launched binary options platform CTOption shared his view with Forex Magnates: “In the short term we certainly anticipate brands avoiding North America and similar jurisdictions as this involves major technological and operational changes requiring significant investments, however In the long term we believe on-exchanges will be the only way to work in regulated environments.”

“We are currently preparing our system for on-exchange integration, and have initiated discussions with NADEX for this purpose.”

Ilan Tzorya, CEO of binary options technology provider Tradologic elaborated on the corporate viewpoint on what lies ahead for entering the United States market whilst remaining within the remit of the regulators: At Tradologic we currently have a policy under which our brands dont operate in the United States. It is clearly stated in the company policy not to offer our platform in jurisdictions where it is contrary to regulations, Mr. Tzorya made clear.

America Land of Opportunity

The United States is a region of future interest to Tradologic, and Mr Tzorya considers the technicalities surrounding the correct method of entering the American market: There is now a huge opportunity to change the binary options industry and we are in the process of developing an additional platform to accept on-exchange binary options. We have started negotiations with NADEX, and are starting to develop a platform that is suited to the US regulations.

In terms of regulation, Mr Tzorya has tremendous respect for the regulatory bodies and understands that by preventing illegal operators, it will improve the market for the legitimate brands in future: If the CFTC is now beginning to act against the illegal websites, this will rule them out and provide good potential for those who operate in accordance with the law to gain more clients. The United States is a good market. We will, however, not go to the market until we are sure that the specification of our platforms relate to the United States requirements. SEC and CFTC are very strong authorities, and Tradologic are investigating several channels to provide binary options in their jurisdiction. he concludes.

Eyal Rosenblum, Co-CEO of software house TechFinancials provided his view on the points of detail to bear in mind when operating in accordance with regulatory rules in the United States: We have very little experience with brokers which work in the US, and have very little access to any information surrounding their activities, as we provide technology solutions for binary brokers, all of which at this stage are in other jursidictions such as Europe and Japan.

Most of our brokers are responsible for their own compliance, therefore we provide software which can be configured to meet regulatory standards explained Mr Rosenblum.

In terms of the North American market, Mr Rosenblum certainly considers it to be a valuable one, however he believes it to be a difficult market to crack because of the cost and development implications that go alongside ensuring compliance with the rulings which stipulate that binary options instruments must be traded on an exchange.

Mr Rosenblum detailed TechFinancials future development plans for US-compliant software to Forex Magnates: We are working with a regulated company in the United States to offer a software solution for brokers to be able to offer their customers a facility to trade binary options in America using our product and our pricing. In the next few months the development will be further toward completion and we hope to be able to offer such a technology package which will be compatible with regulatory requirements.

Currently there is no attractive solution to offer brokers, therefore the only way is to develop further technology as a seperate entity because currently there is no benefit to binary options brokers in going to NADEX. For standard binary options brands, this is not economically viable. We have spoken to NADEX, who asked for the amount of traffic which our brands generate. We discussed this method of working in detail but ultimately it is not likely to be an option for TechFinancials. Even if a broker goes to the expense and effort of gaining a license to operate in America, that broker will still have to go through the NADEX exchange, so therefore they go through all that expense and hard work and the customers end up being NADEX customers explained Mr Rosenblum.

These factors combine to make the United Sates difficult to crack, however we do have a plan of entry and have started discussions with a major US exchange whereby we can offer a regulatory umbrella to brokers and IBs to allow them to work with a product we are developing specifically for the US market whereby it goes through the exchange and the broker will be compensated correctly and it will be in line with US rules. We hope to gain more traction from US brokers as this progresses. The Japanese products are aligned with the US options, the only difference is that Japan still allows brokers to be market makers.

On discussing whether other regulatory jurisdictions may follow the United States in restricting binary options trading to exchanges, Mr Rosenblum considers this very unlikely: I dont think other jurisdictions will do the same as the United States because the regulatory structure is completely different. In America, every trade must go through an exchange, and market making by individual binary options companies is illegal. I do not see any reason for the EU or Japan to act on this basis. We do see something happening in Japan at the moment whereby the time windows in which an option can be executed will be restricted, but market making is still legal.

For this reason, as a technology company, we built our offering to appeal to the Japanese market, where binary options trading is very popular. We have made developments to our offering which are in accordance with the new regulations effective July 17, when we will announce and present the product to the brokers.

Finally, when considering the value of going into America with an exchange-compatible system, Mr Rosenblum concluded: For us, the exchange environment is interesting. Not only will the software and trading experience be different for those who have not operated in America before, but the brokers themselves will also have to adapt, it will be different. Adaptability is the key to survival.

Whilst from a platform conformity perspective, the software developers are able to engage in designing new platforms to enable their brands to operate legally in the United States, however there are more considerations to bear in mind.

The NADEX Factor

According to President and CEO of NADEX Yossi Beinart, market participants have two choices when considering a means of establishing compliant binary options services on the American market.

Mr Beinart explained to Forex Magnates: “The choices that stand are that binary options companies can either become an exchange and compete with us, or they can become a broker and act as an agent on the exchange for their clients in a similar way to how it works in the stock market.”

“Investors then instruct a CFTC regulated agent to represent them on the exchange, in return for a commission.”

When asked whether a sudden dramatic interest in NADEX could come about due to it being an established venue that can facilitate legal entry into the US market for so many binary options brands, and with the software companies already looking at compatibility, Mr Beinart considers the potential change in operating method to be not an easy task: “The only legal way to operate in the US is to come to NADEX, as off-exchange binary options are illegal.”

“I sincerely hope that the companies which want to offer these products will come to us. Whether they will or not I do not know, as this would requires dramatic change in their business model” said Mr Beinart. “The US model is that if you are providing services to retail investors, everything must be exchange listed.”

Mr Beinart confirmed that another means of entering the market is to become a market maker on the exchange. As a market maker, participants can quote their side of the market. This is perfectly legal under CFTC regulations.

“It is a complicated and expensive process whichever method is chosen” Mr Beinart commented. “It can take two to four years to become an exchange and costs a great deal of money, which can run into seven figures” he said.

Transparency of Settlement

According to Mr Beinart, there is an opportunity for binary options software providers to offer a solution that is US compatible. “They can then concentrate on marketing and then direct order flow to exchange. There is room for this, but it will require a very different business model to be adopted” he said.

“NADEX experiences longer lifetime values than the those providing tradition OTC product. This is often used as a real trading vehicle. It’s a different market which could be a good one to enter if done correctly”.

To follow on from this, the US regulators are interested in transparency and all activity must be accounted for. This is part of the reason why it is mandatory to trade all instruments through an exchange.

“When a contract settles on an exchange, the settlement process is transparent” Mr Beinart explains. “It is a contract, with member A on one side, member B on the other. If someone questions the prices, a report can be sent to the client along with the calculation. We are required by the CFTC to make sure that we are transparent and that our settlement prices have a formula with which we can demonstrate how we arrived at that figure.”

“The market is much more representative of probabilities which is what trading binary options is about. I think quoting a two-sided market is a good and fair method”.

Functionality differs from that of off-exchange binary options in terms of the trading experience offered to clients insofar as that placing trades through an exchange allows traders to close positions before the market settles. “A lot of up/down binaries don’t allow this, as a fixed option with a fixed expiry time is often provided. This difference makes the exchange traded option a real trading product. If you see the price move, you can sell at any time” Mr Beinart explained.

Room for Market Makers

NADEX is an open exchange which can accommodate individual members who wish to set themselves up as market makers. “If someone thinks they are a really good trader, they can become a member of the exchange and trade individually, or even set up as a market maker” said Mr Beinart.

“This entails being at the exchange at certain times, providing a two-sided market which is of benefit to the market maker because it makes the fees lower than if an occasional trader. We are required to provide an even playing field. If you want to be a market maker, you can. Business is conducted on an equal access basis”.

The dialog within the industry appears to indicate that the options available to the management teams of companies in this sector are indeed binary either abide by the law and restrict service to certain jursdictions only, or the method in which these instruments can be traded must evolve to meet the needs of the ever toughening international regulatory structure.