2021: Online Trading Platforms and Risks to Investor Protection

Related Practice Area: Financial Services

Among several events that 2021 will be remembered for, this year will probably go down as the year in which financial markets saw unprecedented levels of trading volumes, ostensibly due to the increased participation of retail investors making use of a variety of online trading platforms offering investments with low or no transaction costs and, in some cases, with the possibility of fractional trading. 

Although it remains to be seen whether this activity will constitute a new normal, there is no doubt that the surge in trading volumes presents new risks related to investor protection, especially in the provision of “non-advised” investment services.

What Protection Do Maltese Investors Enjoy? 

Currently, under Maltese law, online trading platforms offering their services in or from within Malta must first obtain the applicable investment services licence from the Malta Financial Services Authority (“MFSA”) and their activities will then be subject to the supervision of the MSFA once the licence has been issued.  

When signing up to a Maltese or EU passported trading platform, investors should have peace of mind that their assets will be segregated from the assets of the  service provider - therefore protecting them from insolvency risks associated with their choice of service provider. 

Another cornerstone of investment protection in Europe is the requirement to properly categorise an investor depending on their means, as well as their understanding of financial markets - this in order to assess the suitability of an investment and the appropriateness of the investor prior to offering an investment or making  any recommendation. 

However, since the majority of online trading platforms are being used to procure “non-advised” services, investors should be aware that they will lose certain protections that would otherwise be available to them. 

In this regard, under the Rules published by the MFSA transposing the Markets in Financial Instruments Directive II (“MiFID II”), online trading platforms offering execution or reception and transmission of orders may provide those services without any requirement to assess the knowledge and experience of the client (the “Appropriateness Test”), when the service relates to “non-complex” financial instruments and when it is provided “at the initiative of the client”. 

In this regard, the main obligation of the online trading platform is merely to inform the client that it is not required to conduct an Appropriateness Test and that consequently the corresponding investor protections will be lost.  

Where a financial instrument is deemed to be “complex”, local rules require the service provider to carry out the Appropriateness Test, pursuant to which, it must assess whether the services should be provided to the investor on an “advised” or “non-advised basis”.

The extent to which online trading platforms are observing these rules remains unclear, although it has been noted that a number of licence holders around the EU are being cautioned or fined by regulators in respect of shortcomings arising in this regard.  

In an apparent act of recognition of the risks to investor protection posed by online trading platforms, on 29 January 2021, the European Securities and Markets Authority (“ESMA”) published a consultation paper on draft guidelines  regarding certain aspects of the MiFID II appropriateness and execution-only requirements.

It appears that ESMA is primarily concerned with the lack of uniform application of several areas of the appropriateness and execution-only requirements by investment firms across different Member States. 

Some key aspects of the guidelines include:

- the duty to inform investors on the utility of the Appropriateness Test and to make proper determinations when this is required;
- the effectiveness of the warnings to investors; 
- the extent of information which must  be obtained from investors and its reliability;
- staff qualifications; and
- record-keeping. 

ESMA has invited interested stakeholders to provide their feedback on the proposed guidelines by 29 April 2021.

The easy access to financial markets through online trading platforms is seen as a step forward in the democratisation of investing and it is anticipated that any steps taken by regulators to curtail this participation will be met with resistance.

However, it remains an accepted fact that short-term trading is an extremely complex endeavour and retail investors speculating in financial instruments should be mindful that they are ultimately competing against sophisticated institutional investors that have the advantage of having robust research budgets and quicker access to market data through costly technologies.

Retail investors should therefore be cautious when investing on online trading platforms and should heed to the various warnings received in the course of trading. 

At the same time, investment services providers should seize the opportunity behind the increased participation of retail investors to educate investors, promote diversification and long-term investing and to attempt to bridge the gap created by information asymmetry in financial markets. 

 

 

Author:  Alain Muscat

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