A quick look into South Africa’s Over-the-Counter Derivatives Providers (ODP) licence registry reveals an interesting trend: out of 70 non-banks on the register, 4 companies gave up their licenses, while 26 withdrew their applications. IG Group was one of the big names that established a presence there and then completely exited the country. This raises the question: what is creating this exodus from the South African ODP regime?The High Cost and ‘Rigorous’ Requirements Are Chasing Brokers OutThe mass exodus might be due to the strict operational rules imposed by the FSCA on all ODP licence holders, along with harsher penalties and increased audit requirements. “In addition to an increasingly scrutinous licensing and supervision approach, the FSCA has made the costs of operating an ODP in South Africa very high,” said Nikolas Xenofontos, Managing Director at SALVUS Funds.Some of the operational requirements for ODP licence holders include a fixed address with staffed offices, internal compliance functions, internal accountants and auditors, one or more KI, and three locally based executive directors.“Often these requirements balloon monthly costs,” Xenofontos added.Read more: IG Group to Exit South AfricaScope Markets’ South Africa CEO, Robert Van Eyden, believes that “many firms might have underestimated the local requirements or chosen not to commit the required resources.”He further highlighted that the process required meaningful management time, specialist input, and internal capacity. Costs vary by firm, but the bigger consideration is the ongoing human capital and governance burden rather than just the initial spend.Although applications can be submitted on paper, the South African regulator’s requirements have made it very difficult for foreign-owned companies to obtain an ODP licence.“The FSCA's focus on 'substance over form' means that providers cannot simply operate as a ‘letterbox’ entity,” said Shreelin Naicker, Departmental Head for Markets, Issuers & Intermediaries at the FSCA. “They are expected to maintain robust, onshore risk management and IT infrastructure capable of real-time reporting to a local Trade Repository.”He further revealed that the regulator has intensified its scrutiny of anti-money laundering (AML) and know-your-customer (KYC) protocols following the country's exit from the FATF grey list.“For some foreign providers, the risk of getting into trouble because of these evolving enforcement standards and the potential for subsequent reputational damage outweighs the projected commercial gains from a retail market that, while growing, remains a fraction of the size of European or Asian jurisdictions,” Naicker continued, adding that the regulator has licensed several foreign non-bank providers that meet the ODP licence requirements.Indeed, there are many big names operating locally in South Africa under the ODP regime. Exness, Scope Markets and ATFX are a few prominent names that still hold ODP licences and operate locally. Capital.com is one that has even recently secured an ODP license in the country, showing that it is still possible to acquire one even with the heavy restrictions.Related: Capital.com Enters South Africa with Dual Local Licences; Ex-IG Exec to Head Operations“The requirement for an ODP licence is triggered the moment a firm moves beyond intermediation to act as a principal counterparty to its clients,” Naicker added. “Even if a firm seeks to hedge its exposure through back-to-back transactions with an external provider, the FSCA views the initial contract with the retail client as a principal-to-principal transaction, which necessitates ODP authorisation.”“Effectively, if a broker is the counterparty responsible for holding client margin on its own balance sheet and fulfilling the obligations of the trade, they have crossed the threshold from a service provider under the FAIS Act to a product issuer under the Financial Markets Act.”The regulator also admits that the ODP requirements are “rigorous”, but they are not meant to be prohibitive.Scope’s Van Eyden also thinks that the ODP regime is “positive for long-term credibility and client protection.”“A Combination of Practical and Commercial Considerations”When the brokers that withdrew their ODP licence applications were asked about the reasons behind their decision, they pointed to commercial considerations.Infinox, one of the CFD brokers that withdrew an ODP application, highlighted that its decision was part of “a broader assessment of its priorities and market focus”. “The withdrawal was not the result of any specific regulatory issue or rule affecting INFINOX in isolation,” a representative of the broker said.Another broker, speaking on condition of anonymity, said that it was an “operational decision”.One broker, however, was explicit about the role of strict regulations in its decision to give up its ODP licence.“The decision to withdraw our ODP application was ultimately driven by a combination of practical and commercial considerations,” a QuickTrade spokesperson said. “We determined the regime isn’t financially or operationally viable for our business.”“The compliance burden associated with obtaining and maintaining an ODP licence was significant, while, from a client perspective, there was very little evidence that holding an ODP licence materially influenced client demand or client decision-making.”Going the FSP RouteDozens of CFD brokers, on the other hand, are opting for a much simpler Financial Service Provider (FSP) licence in the country. Although it offers a low-barrier, regulated entry into the market, it has a major limitation: FSP-licensed brokers cannot act as market makers.A broker holding an FSP licence is permitted to act strictly as an agent or intermediary, providing financial advice or facilitating transactions where the client enters into a contract with a third-party issuer. The FSP does not take the opposite side of the trade and has no direct exposure to the market movement of the derivative; the contractual relationship exists between the client and a separate external product provider.You may also like: CFD Brokers Flock to Dubai, but Few Go All InMany broker brands that have either given up their ODP licence or withdrawn their applications now hold an FSP licence.On the marketing front, an FSP licence also gives brokers an opportunity to show a local presence in South Africa. However, whether they are strictly adhering to it is a completely different matter.Finance Magnates confirmed that at least one broker, which gave up its ODP licence and now holds an FSP licence, is onboarding South African clients under its Seychelles unit.“There is a risk that some offshore players will continue targeting South African clients, which creates an uneven playing field, but over time I expect regulation and client awareness to favour authorised providers,” Van Eyden continued.The South African regulator, meanwhile, highlighted that it is “strictly mandatory” for CFD brokers, whether local or offshore, to obtain a local licence, either FSP or ODP, “if they intend to actively market their products to South African residents.”However, the key phrase here is “the act of ‘marketing’”, which the FSCA classifies as a financial service. It can also be interpreted to mean that a broker's FSP-licensed entity must conduct marketing within the country, while clients may be onboarded under an offshore unit.“When an offshore CFD broker markets to South African traders without authorisation, the FSCA responds with a range of enforcement actions designed to disrupt their operations and protect the public,” Naicker added. “The first and most common step is the issuance of a formal public warning, which names the entity and explicitly states that it is not authorised to provide financial services in the country. If the activity persists, the FSCA can impose substantial administrative penalties.”This article was written by Arnab Shome, Adonis Adoni at www.financemagnates.com.