Financial Services Regulation

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Unravelled: Pseudo-investments and mobile apps – a new frontier for regulators

4 October 2017

Written by Managing Associate Simun Soljo and Lawyer Michal Magat

It is hardly surprising that the Australian Securities and Investments Commission (ASIC) has taken an interest in the mobile app market, given that there has been an aggressive expansion into the mobile space by financial services providers. The targets of ASIC's recent investigations have been the residents of the darker corners of the app stores, which facilitate a pseudo-investment subculture that seeks to operate outside the usual regulatory environment. Citing concerns about unlicensed financial services activity and associated consumer protection risks, ASIC cracked down on web and mobile based OTC derivative providers in July 2016, and, in March 2017, it requested the removal from the Apple and Google stores of more than 330 apps that facilitated binary options trading (BOT apps). In this article, we focus on issues that arise in connection with BOT apps.

Binary options trading

Binary options provide a simple way to speculate about price fluctuations in the value of a range of assets, commodities, foreign currency exchange rates and financial markets across the world. An investor purchases an option from a broker by selecting an asset or index, setting a strike price or value, and a maturity period for the option that typically varies from a few minutes to a number of months. What makes the option binary is that the investor then chooses whether the value of the thing will be above or below the strike price at the time of maturity. If the option matures at the correct side of the strike price, the investor receives a set return. However, if the prediction is wrong, the broker pockets the whole (or almost the whole) investment.

Since binary options are tied to tradeable items and market indices, an investor's ability to profit from them ostensibly relies on the investor's knowledge and analysis of the likely future performance of the relevant asset or index. Binary options also offer certainty about the amount of potential profits or losses, because these are set when the option is purchased and are not dependant on how much the market moves in the right or wrong direction beyond the strike price. Some brokers also allow investors to trade in options, to buy and sell them before they reach maturity, and thus to either secure a reduced profit or avoid further losses as the likelihood of the option reaching maturity on the correct side of the strike price rises or falls.

Despite the extensive use of investment language, binary option trading is little more than a form of all-or-nothing gambling. And, as is the case in many forms of gambling, the house has an advantage. While an option may pay a return of up to 80 per cent if the investor makes a correct prediction about the direction of the relevant value, losses range from 85 to 100 per cent of the invested amount, meaning that an investor has to be correct more times than not to break even.

Binary options trading and mobile apps

While the Chicago Board Options Exchange offers binary options trading to sophisticated and institutional investors (despite a June 2013 risk warning issued by the US Securities and Exchange Commission), mobile apps target ordinary consumers.

With snazzy designs and moving charts aplenty, the BOT apps exploit not only the desire of consumers to share in the vast profits made by institutional traders, but also the appeal of a mobile interface that seems to provide an immediate link for the investor to the investment markets, while simultaneously reducing investment to a simple yes/no choice. Interestingly, with most binary options worth $100 or less, the investor may also be made to feel safe by being required to risk only a relatively small amount of money on every spin of the pseudo-investment roulette.

ASIC review

ASIC found that many BOT apps failed to comply with licensing obligations, made extravagant and misleading claims about the profit potential of binary options, failed to outline trading risk, and did not provide adequate risk warnings.

A quarter of the BOT apps were described by ASIC as 'signal providers', that is apps that analyse, or purport to analyse, various market and social media trends to provide binary option trading predictions of often over-exaggerated reliability. ASIC also found that some binary options review and education sites were designed to collect personal information, which was supplied to brokers who engaged in high-pressure cold calling, while some did not disclose referral fees they received from brokers.

Regulating trading on the mobile market

While ASIC praised the speed with which both Apple and Google responded to its request to remove the BOT apps from their stores, the regulation of pseudo-investments offered via mobile phone apps is likely to be an ongoing problem.

Apple prides itself on reviewing all apps submitted to its store, and its review guidelines now prevent the inclusion of apps that facilitate binary options trading. In contrast, Google relies on users to flag inappropriate apps, although it too has taken some steps to vet apps. However, neither Apple nor Google have had (or can hope to have) a clean track record of quickly and consistently excluding apps that fall outside their guidelines. Given the low fees charged for placing an app on either store, brokers will perhaps conclude, in spite of a crackdown, that it's worth having a punt.

So far, hanging out a shingle in the mobile space has proven easy, immediate, largely anonymous and outside the scope of what regulators have targeted on a daily basis. This has benefited those who openly flaunted consumer protections laws and the regulation of financial services and products.

While ASIC's recent actions may have limited the activities of the more brazen binary options traders, the combination of human ingenuity and greed that has inspired their conduct so far may well lead to binary option trading and other pseudo-investments being conducted on the mobile platform in more subtle ways. Even if ASIC had capacity to regularly review and take action against unlicensed and risky financial activity facilitated by the mobile market, the brokers are bound to respond by launching apps designed to outsmart and stay one step ahead of both the app store review processes and any future ASIC investigations.

Finally, as the cost and conduct of more and more regulatory services is being shifted away from government agencies and onto market participants, we may pause to consider whether it is fair to expect Apple and Google to police their stores for unregulated financial services activity on top of content and functionality testing we already expect of them. And if they don't become pseudo-financial regulators, ASIC may need to continue to review and scrutinise the apps made available to customers.

Other article in this edition of Unravelled

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FX global code update
The FX Global Code was launched in Australia earlier this year and applies to 'market participants', including most financial institutions, bank asset managers, brokers and E-trading platforms. The Code sets out 55 best practice principles and, although compliance is voluntary, it is expected that these principles will become the standard for the FX market industry. Read more>>

Spring overhaul of Australia's market licensing regime
Australia's market licensing regime has long been crying out for an overhaul, with regulatory guidance that largely dates back to the early 2000s struggling in the face of significant developments in financial markets since then. Fortunately, ASIC has taken heed and is due to release an updated market licensing regulatory guide this month. If the draft guidance is anything to go by, we should soon see a much more modern and flexible approach to market licensing. Read more>>

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