Social Trading and Regulation Part 1: Copy Trading and Regulation

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Social and Copy Trading – which we covered in our Guide to Copy Trading┬áseries – are becoming an an increasingly big part of the online trading landscape, offering an easier route into trading for investors, and a way for experienced traders to gather additional capital to trade with.

As is often the case when a new and disruptive technology or business model comes along, the regulators have been slow to get to grips with social and copy trading. The lack of coherent regulation, or guidance as to how the existing regulations surrounding online trading should apply, has created something of a grey area around this emerging field.

In many ways, the lack of regulation around social and copy trading has echoed the situation that existed in the late 1990s and early 2000s, when the first online trading platforms appeared, and there was little or no regulation in place to protect clients. Now that social/copy trading has been with us for a few years, and has firmly established itself as an increasingly important part of the online trading ecosystem, regulators have finally recognised the need to provide a legal framework for brokers that offer these services.

The first regulators to act have been the Financial Conduct Authority (FCA) in the UK and the Australian Securities and Investments Commission (ASIC), both of which are in the advanced planning stages of regulating copy trading, auto trading, and mirror trading. Although the plans have not been finalised, it looks as though both regulators will require trade leaders and PAMM managers to hold an appropriate money managers license, even if they do not actually hold client funds.

If this regulation goes ahead, as seems likely, it could put the brakes on the rapid expansion of copy trading that has been going on for the past couple of years. At the moment, on most platforms at least, anyone can set up an account, start trading, and allow others to copy their trades either manually or automatically. In most cases, they do not charge to allow others to copy their trades, and these traders will be less likely to be required to hold licenses.

However, making money from subscriptions or commissions for copying trades is the main incentive for trade leaders in most social trading platforms. If these traders were all required to obtain licenses, it would most likely put a lot of them off, significantly reducing the pool of successful traders willing to share their trades with the public. This could lead to a ‘brain drain’, where copy trading platforms become populated almost exclusively by relatively inexperienced traders, with most of the better traders taking their trades back into the private domain rather than jumping through the necessary regulatory hoops.

Of course, one other potential outcome is that the legitimisation of copy trading encourages more professional, licensed money managers – and there were a lot of them put out of work by the financial crisis – into the fold. Although it is unlikely this would happen immediately, it could have a transformative effect on the industry, bringing it much closer to the personal investment mainstream.

There are numerous other questions surrounding this issue, such as whether trading signals provided via social trading platforms constitute ‘investment advice’ and would therefore require a license, or whether the regulatory burden should be shouldered more by the brokers or the signal providers. In this series, we will be looking at the potential issues – and benefits – that could arise as a result of copy trading regulation, and how it is likely to shape the industry in the years to come.

In the meantime, here is a video of a Securities Trader Association panel discussion on the topic of social media and finance, which covers many of the issues we shall be discussing in this series:
Traders on Twitter: The Securities Trader Association Tackles Social Media in Finance