Proprietary trading, or “prop trading,” has always been a high-stakes and fast-paced sector of the financial markets.
Prop trading firms, which trade their own capital in various financial instruments, are seen as innovators in trading technology and strategy.
However, with innovation comes increased regulatory scrutiny.
In 2024, new and evolving regulations are reshaping the landscape of prop trading globally.
This makes compliance more complex and critical than ever before.
This comprehensive guide aims to help you navigate the key regulatory developments. These latter affect the prop trading sector in 2024 and beyong.
It also provides insights into how firms can stay compliant while maintaining competitive advantage.
The global regulatory environment: A changing landscape
The global regulatory environment for prop trading has become increasingly intricate as national and international regulatory bodies introduce new rules.
These latters are aiming to curb risks and ensure financial stability.
These regulations, which focus on everything from market transparency to risk management, are primarily driven by the need to protect markets. However, from what?
From excessive volatility and systemic risks that could arise from high frequency trading (HFT) and other aggressive trading practices.
In 2024, regulators in key financial markets, such as the United States, European Union, and Asia, have taken steps to address market abuse, transparency, and systemic risk.
For instance, the Securities and Exchange Commission (SEC) in the U.S and the European Securities and Markets Authority (ESMA) have both introduced stringent rules around algorithmic trading, requiring firms to implement robust monitoring and control mechanisms.
Understanding these global regulatory frameworks and adapting to region-specific requirements is crucial for prop trading firms.
Especially, those who operate across borders.
Most important regulatory frameworks for prop trading in 2024
MiFID II/III and its Impact on prop trading in Europe
One of the most important regulatory frameworks for prop trading in 2024 remains the Markets in Financial Instruments Directive (MiFID II) in Europe, and its potential successor MiFID III.
MiFID II, which came into force in 2018, introduced a wide range of measures aimed at increasing market transparency.
Alternatively, reducing risks associated with algorithmic trading and dark pools.
For prop trading firms, MiFID II imposed stricter reporting requirements and enhanced scrutiny over algorithmic and high frequency trading (HFT) activities.
Key areas of focus include:
- Algorithmic trading controls: Firms are required to ensure that their algorithms are well monitored, with “kill switches” in place to shut down algorithms if they behave erratically. Regulatory authorities want firms to demonstrate that they have risk controls that mitigate the risk of excessive trading activity, which could destabilize markets.
- Transparency: MiFID II introduced extensive post-trade transparency rules for equity and non-equity markets. Under MiFID III, this transparency may be extended even further, requiring firms to provide more detailed information on their trading activities.
- Best Execution: Prop firms must show that they consistently achieve the best possible results for their clients when executing trades. While this does not directly affect firms trading their own capital, it sets a standard that all trading activities, including proprietary ones, must adhere to. Navigating the evolving MiFID landscape requires robust compliance frameworks, clear internal governance, and a deep understanding of algorithmic controls.
SEC and CFTC regulations in the U.S.
In the U.S., the Securities and Exchange Commission and the Commodity Futures Trading Commission oversee proprietary trading activities.
These regulatory bodies have introduced a host of new measures to curb market abuses and mitigate the risks of algorithmic trading.
One of the most significant developments in 2024 is the Increased Monitoring of High-Frequency Trading (HFT).
HFT has long been a controversial practice due to its potential to cause market volatility.
Both the SEC and CFTC have ramped up their surveillance of HFT activities to prevent manipulative trading practices like spoofing and quote stuffing.
Firms are now required to report their algorithmic trading activities more frequently and in detail.
This action is done to ensure that regulators have a clear view of how algorithms interact with the markets.
Additionally, the SEC’s Regulation Best Execution requires prop firms to disclose how their execution strategies align with best execution standards.
This requires firms to keep comprehensive records of their trades and decision-making processes, making compliance more complex.
The CFTC and SEC have placed a greater emphasis on prop firms implementing real-time risk management frameworks.
This helps to detect anomalies in trading patterns, limit market exposure, and prevent systemic risk.
Asia’s regulatory frameworks: Hong Kong, Singapore, and Japan
Asia has emerged as a significant hub for prop trading.
In 2024, regulators in key financial centers like Hong Kong, Singapore, and Japan have implemented their own rules governing proprietary trading.
In Hong Kong, the Securities and Futures Commission (SFC) has strengthened its focus on algorithmic trading and cybersecurity.
The SFC now requires firms to register their algorithms. Moreover, to ensure that they are subjected to thorough testing and monitoring.
This includes a focus on cybersecurity protocols to protect against external threats, which have become more sophisticated in recent years.
In Singapore, the Monetary Authority of Singapore (MAS) has taken a more pragmatic approach, focusing on balancing innovation with regulation.
MAS continues to support fintech development while ensuring that prop firms operate within a well-regulated environment. Particularly around risk management and liquidity provisions.
Meanwhile, Japan’s Financial Services Agency (FSA) has prioritized market fairness and integrity.
They aim at preventing market manipulation and ensuring transparent trading practices.
For prop trading firms operating in Asia, staying compliant means understanding the nuances of each regulatory environment. Especially as many of these regions, take divergent approaches to fintech and innovation.
Anti-Money Laundering (AML) and Know Your Customer (KYC) obligations
While traditionally more relevant to retail financial services, AML and KYC regulations have increasingly become a focal point for prop trading firms, especially as they expand into cryptocurrency and decentralized finance (DeFi) markets.
In 2024, regulators around the globe have stepped up their scrutiny on how firms are conducting their due diligence in these areas.
Prop firms are now required to have robust AML and KYC frameworks in place, even when dealing with their own capital.
This includes identifying and verifying counterparties, especially in digital asset transactions.
The rise of DeFi protocols, which often lack centralized oversight, has made it more difficult for firms to comply with AML/KYC rules.
Environmental, Social, and Governance (ESG) regulations
ESG regulations have become an integral part of the financial industry, and in 2024, they are having a growing influence on proprietary trading.
Regulators are increasingly demanding that financial institutions, including prop firms, align their activities with ESG principles.
For instance, regulators in the European Union have mandated that firms disclose the ESG risks associated with their investments. Even, if those investments are part of proprietary trading strategies.
This could mean assessing the carbon footprint of assets, ensuring that trading strategies do not contribute to unsustainable practices.
In addition to that, increasing transparency around how ESG factors are integrated into decision-making processes.
ESG compliance is becoming not just a regulatory necessity but also a reputational one.
As firms that do not align with these principles may face backlash from investors and clients alike.
Cybersecurity and data protection
As proprietary trading becomes increasingly dependent on data-driven strategies and sophisticated algorithms, the need for robust cybersecurity measures is more critical than ever.
In 2024, regulators around the world are placing a renewed focus on cybersecurity in the prop trading sector. This sector is driven by the growing frequency and sophistication of cyber attacks.
Prop firms are required to demonstrate that they have strong data protection frameworks in place.
This includes encryption, multi-factor authentication, and regular penetration testing.
Regulatory bodies such as the SFC in Hong Kong and ESMA in Europe have made cybersecurity a top priority, with stringent penalties for firms that fail to protect sensitive trading data.
Conclusion
In 2024, proprietary trading firms are navigating a complex and rapidly evolving regulatory landscape.
From algorithmic trading controls and AML/KYC obligations to ESG regulations and cybersecurity, staying compliant is both challenging and essential.
Firms that prioritize a proactive approach to compliance invest in strong risk management frameworks, and embrace technological innovation will not only avoid regulatory penalties but also gain a competitive edge in this fast-paced and high-stakes industry.
Read also: The United Arab Emirates (UAE) strengthens its regulatory position in the crypto sector