Electronic web-based trading platforms enabling investors to enter into off-exchange (OTC) transactions in financial instruments, such as securities, units in mutual funds and derivatives based on currencies, commodities, interest rates, exchange rates and stock exchange indices will shortly become subject to regulation in Israel.
The growth of internet commerce in general has seen an emergence of unregulated internet financial trading platforms, providing an alternative to the trading services provided by the banks (and regulated by the Bank of Israel). Although such unregulated electronic trading activity in Israel remains relatively limited in nature, the Israeli Securities Authority ("the ISA") has identified this as a developing trend and consequently in need of regulation.
For unsophisticated investors, in particular, investment via unregulated electronic trading platforms involves considerable risk. Most investors lack the expertise to understand the implications of their investments and without proper guidance can easily find themselves making investments which do not accord with the level of risk they intend to assume. Further, investors via electronic trading platforms which do not disclose conflicts of interest and other information relevant to an investment, will not be able to evaluate an investment opportunity properly. It is principally for these reasons that the Israel Securities Authority ("the ISA") has sought to introduce the licensing and supervisory measures now coming into force.
In furtherance of this objective, an amendment to the Securities Law, 1968 was enacted in 2010, pursuant to which only the holder of a licence issued by the ISA ("Platform Licence") would be permitted to operate an electronic trading platform ("the Amendment"). The Amendment laid down certain criteria for the application for and obtaining of Platform Licences and also empowered the ISA to supervise the activity of electronic trading platforms. The Amendment provided that it would become effective only upon the enactment of enabling regulations.
Such regulations, the Securities Regulations (Trading Platform for Own Account), 2014 ("the Regulations") were approved recently by the Finance Committee of Israel's Parliament (the Knesset) and now await only the signature of the Minister of Finance for publication and entry into force. The Regulations provide in considerable detail for the supervision, management and regulation of electronic trading platforms. The Regulations provide that they become effective six months after their publication, during which period platform operators may apply to the ISA for a Platform Licence. The Regulations provide that an operator which has filed such application may continue to operate the platform during the interim period and until a decision on the application has been made.
In addition to the licensing requirement (which applies both to the operation of an electronic trading platform in Israel and also to such platforms operated from outside Israel if directed to Israel residents), the Regulations include, inter alia, provisions defining the leverage cap permitted for different types of financial instruments, establishing a mechanism for dealing with conflicts of interest, detailing the information which the electronic trading platform operator is required to provide to its clients and specifying reporting duties to the ISA.
It is important to note that the formal counter-party to the investor in these electronic internet transactions is the operator of the platform buying and selling for the operator's own account and not other investors. An electronic trading platform enabling transactions between investors will be treated as a stock exchange and will require a stock exchange licence.
Features of some of the main provisions of the Regulations follow:
- Application for a licence – entities wishing to operate an electronic trading platform will need to apply to the ISA for a Platform Licence. The application must include updated financial statements of the applicant operator as well as details of all supervisory and risk management measures currently taken by the applicant operator.
- Leverage cap - the security required to be provided by a client cannot be less than 5% of the face value of a specific transaction in high-risk transactions; 2.5% in medium-risk transactions; and 1% in low-risk transactions.
- Conflicts of interest - each applicant operator will be required to provide a document describing the likelihood of any potential conflict of interests arising and its policy for dealing with such a situation. An electronic trading platform operator will be required to inform its clients of any potential or actual conflict of interests and will be prohibited from providing a client with investment advice relating to a financial instrument in which the operator trades.
- Client funds - client funds will be required to be kept separate from the operator's own funds in a trust account managed by a bank.
- Reporting to clients - operators will be required to submit a comprehensive monthly report that will include, inter alia, details of all client operations, transactions, fees, charges, etc.
To sum up: electronic trading platforms can provide an efficient and easily-accessible trading system, which could be to the benefit of many investors. However, this alternative trading system comes at great potential risk to unsophisticated investors. The Amendment and its enabling Regulations are intended to facilitate electronic trading while providing investors with some measure of protection.