Social Trading Regulation and MiFID II – Discover how they work
Given the increasing interest that is developing around this area, it’s normal that more and more users are interested in Social Trading Regulation, particularly in Europe where the regulation of the financial sector is increasingly stringent.
In this post we will see precisely what is the Social Trading Regulation (also for Copy Trading and Mirror Trading) in Europe.
Specifically, we will talk and explain what the MiFID Directive is.
Finished this post, you can deepen the subject discovering how ZuluTrade, one of the main companies in the sector, has had to change its Copy Trading platform just to adapt to the European Social Trading Regulation.
We explain it in detail in this post.
But let’s order.
What is MiFID and why it exists
MiFID, acronym of Markets in Financial Instruments Directive, is a European Union directive, born back in 2004. This directive contains a long list of requirements and standards to which all participants in the European financial markets must adhere to.
The main objective of MiFID is to create a European financial market in which encouraging honest competition between the participating companies, and at the same time increasing consumer protection.
The first introduction in 2004, of what we can call MiFID I, was a significant and positive change for the industry.
Everything was going the right way, and the new legislation, which came into full force in 2007, finally replacing the old ISD (Investment Services Directive), seemed to have improved and made the European financial landscape safer.
Well, it’s appropriate to say: “famous last words”.
In 2007 began what today we know as the global financial crisis. Starting from the US subprime and moving to the European countries debt, the entire global financial system was on the brink of collapse.
The crisis, however, had the merit of highlighting all the weaknesses of MiFID I, weaknesses that most likely would not have been identified in normal market conditions.
In several areas there was a lack of transparency and controls, in other areas, instead, there were still no sufficient protections for investors. In addition, the unstoppable technological development of these decades had given life to new problems that needed a prompt and serious supervision.
It was at that time that HFT (High Frequency Trading), and more generally all the Algorithmic Trading, became the main accused of many system malfunctions (see the famous Flash Crash of 2010).
There was so much to do to make the system more solid and secure, and at the dawn of 2010, for the European Union legislators it was time to upgrade, integrate and improve the whole MiFID.
The “discovery” of Copy and Mirror Trading
The start of the consultation for the MiFID I updating was the occasion for the European authorities to turn their attention to a new way of investing that was rapidly spreading all over the world thanks to the technological development. Yes, we are talking precisely of Social Trading.
But, we need to be more accurate in this case. Not all Social Trading, but only the subsets of Copy Trading and Mirror Trading.
- Pure Copy Trading is the practice of replicating trading signals generated by a trader, through a platform that acts as the interface between the supplier of the signal (the trader) and the investor who copies it.
- Pure Mirror Trading instead is the practice of replicating trading signals generated by an automatic strategy hosted on the interface platform.
In essence, they are quite the same, it’s always an entity, being it machine or human, that generates a signal to buy or sell, which is transmitted to the investor and that is replicated on his personal account.
The authorities put special attention to the fact that this process was fully automated, i.e., once the choice of the traders or strategies from which to copy was confirmed, the investor could very well stop following the trading activity, because everything was done automatically, and buys and sells orders came easily and instantly to the investor’s account, even without the need of the computer to be turned on or to keep programs always running.
The beauty of this new system was exactly this, i.e. the ability to copy effortless from strategies or trader who had already proven to be profitable.
The new Social Trading Regulation
From the authorities point of view, however, these systems were creating a different scenario on the legislative front.
Despite the trading account remained owned by the investor, and there was no delivery of money to a third party, in any case the investor’s capital was moved and managed by an external entity, and this was enough for the authorities to equate Copy trading and Mirror trading to the asset management disciplines.
The dividing line was only one. If the trading signal generated by the trader or by the strategy was then replicated automatically and without any confirmation from the investor, then that was classified as asset management. Period.
If instead the investor had to confirm the buying or selling signal, and operate manually, that case was no longer asset management, but simple advice.
What happened then?
It happened that all the companies that were offering Copy Trading or Mirror Trading services had to adapt to the same MiFID regulations planned for the asset management companies, which, as you can imagine, were different.
And here’s where we finally arrive to ZuluTrade.
Prior to this regulatory update, this society was considered an IB (Introducing Broker) and a service provider. Essentially, the company was the medium through which customers were finalizing the opening of trading account among various forex brokers; plus, it also provided an automatic signals replication service, precisely what we call Copy Trading.
Now, with the update to MiFID II, ZuluTrade is still an IB, and is always a service provider, but it’s also a kind of asset manager , and therefore has been forced to update and revise some of its services.
In the next post we will see together the “Before and After” of this important Copy Trading company as a result of the implementation of the new European MiFID II.