Investment firms and FX brokers: MiFID II licences, capital and leverage limits

Brokers, asset managers, trading venues and FX or CFD providers all sit under investment services regulation rather than banking law. The licence a firm needs depends on three questions: which services it performs, whether it holds client money and assets, and whether it deals against its own book.

This guide explains the European model, which many other regimes borrow from, then the leverage rules for retail CFDs and FX, the limits of offshore broker licences, and the separate Hong Kong regime for leveraged FX.

What counts as an investment firm

In the EU, an investment firm is any firm that provides one or more of the services listed in Annex I, Section A of MiFID II (Directive 2014/65/EU) in relation to financial instruments. The services are:

1. Reception and transmission of orders.
2. Execution of orders on behalf of clients.
3. Dealing on own account.
4. Portfolio management.
5. Investment advice.
6. Underwriting or placing on a firm commitment basis.
7. Placing without a firm commitment basis.
8. Operating a multilateral trading facility (MTF).
9. Operating an organised trading facility (OTF).

Financial contracts for differences are listed as financial instruments in Section C(9) of the same annex. A CFD or rolling spot FX provider that takes the other side of client trades is therefore dealing on own account, which is the most capital intensive permission.

Authorisation under MiFID II

A firm applies to the competent authority of the Member State where it has its registered office. Under Article 7(3) of MiFID II, the authority must take a decision within six months of receiving a complete application. In practice the clock starts only when the regulator treats the file as complete, so preparation time before that point is often longer than the formal review.

The application usually covers the following:

• Programme of operations: services, instruments, client types, target markets and financial projections.
• Management: Article 9 requires that the business be effectively directed by at least two persons who meet the fitness and propriety requirements.
• Qualifying shareholders: identity, source of funds and suitability of anyone holding 10% or more.
• Organisation: compliance, risk management and internal audit functions, conflicts of interest policy, best execution, product governance, record keeping and outsourcing.
• Client asset protection: segregation and safeguarding arrangements where the firm holds client money or instruments.
• AML framework: risk assessment, customer due diligence and a named compliance officer.

Once authorised, a firm can provide its services across the EU and EEA through the passport. Article 34 allows cross-border services without a separate authorisation, after a notification through the home regulator. Host regulators still apply their own conduct rules and marketing restrictions, which matters for CFD providers.

Capital: the IFR and IFD regime

Since 26 June 2021, most EU investment firms have been subject to a dedicated prudential framework rather than the bank rules. It consists of Regulation (EU) 2019/2033 (IFR) and Directive (EU) 2019/2034 (IFD).

Initial capital

Article 9 of the IFD sets three levels of initial capital:

Initial capital	Applies to
EUR 750,000	Firms authorised for dealing on own account or underwriting on a firm commitment basis, and certain OTF operators
EUR 150,000	Other firms, including those that hold client money or assets
EUR 75,000	Firms that do not hold client money or securities and provide only reception and transmission, execution, portfolio management, advice or placing without firm commitment

The UK kept the same three tiers in sterling after leaving the EU. Under MIFIDPRU 4.4 the permanent minimum capital requirement is GBP 750,000, GBP 150,000 or GBP 75,000 depending on the firm’s permissions.

Ongoing own funds

Initial capital is only the entry ticket. Under Article 11 of the IFR, a firm must hold own funds at least equal to the highest of three amounts:

• Its permanent minimum capital requirement.
• One quarter of its fixed overheads for the preceding year.
• Its K-factor requirement, which measures risk to clients, risk to market and risk to the firm.

A firm qualifies as small and non-interconnected only if it meets all of the thresholds in Article 12 of the IFR. These include assets under management below EUR 1.2 billion, a balance sheet below EUR 100 million and total gross annual revenue from investment services below EUR 30 million. Such firms do not calculate K-factors. They also cannot hold client money or deal on own account.

Every firm must also hold liquid assets of at least one third of its fixed overheads requirement under Article 43 of the IFR. For a growing broker with a large cost base, the fixed overheads test often binds well before the initial capital figure does.

Very large firms

The largest investment firms, particularly those dealing on own account at scale, can be brought back under bank prudential rules. Article 1(2) of the IFR allows this for firms with consolidated assets of EUR 15 billion or more in certain circumstances. This affects few new entrants but matters for acquirers of established market makers.

Retail CFD and leveraged FX restrictions

Leveraged products sold to retail clients are the area where regulators intervene most directly. The EU, UK and several Asian regulators cap leverage and require loss protection.

The EU measures

On 27 March 2018, ESMA agreed temporary measures under Article 40 of MiFIR. It banned the marketing, distribution and sale of binary options to retail investors and restricted CFDs to retail investors with five measures:

Measure	Content
Leverage limits on opening a position	30:1 major currency pairs; 20:1 non-major pairs, gold and major indices; 10:1 commodities other than gold and non-major indices; 5:1 individual equities and other references; 2:1 cryptocurrencies
Margin close-out	Positions closed when account margin falls to 50% of the minimum required margin
Negative balance protection	Retail losses limited to the funds in the CFD account
Incentives	No monetary or non-monetary benefits offered to encourage trading
Risk warning	Standardised warning including the firm’s percentage of losing retail accounts

ESMA’s own measures lapsed on 31 July 2019. ESMA explained that most national authorities had adopted permanent national measures that were at least as stringent. Some national rules go further, so a firm passporting into several Member States must check each host regulator’s measure.

The UK, Singapore and Switzerland

The UK adopted equivalent permanent rules. The FCA confirmed leverage limits of 30:1 to 2:1, 50% margin close-out, negative balance protection, a ban on inducements and standardised risk warnings. These applied from 1 August 2019 for CFDs and 1 September 2019 for CFD-like options.

Singapore uses margin rates rather than leverage ratios. In 2014 the Monetary Authority of Singapore decided on a minimum margin of 5% for CFDs on FX and leveraged FX contracts with retail investors. MAS noted this was in line with Hong Kong (5%) and Japan (4%) at the time.

Switzerland takes a structural approach. FINMA states that foreign exchange dealers domiciled in Switzerland must hold a banking licence. It also warns that foreign dealers using Swiss contact addresses or bank accounts may be running an unauthorised branch.

Offshore FX broker licences and their limits

A large part of the global retail FX and CFD market is served from smaller centres. Examples include the Seychelles, where the Financial Services Authority licenses securities dealers, and other island or offshore regulators in the Caribbean, the Pacific and the Indian Ocean. These licences are real authorisations with their own capital, reporting and AML rules, which vary between jurisdictions and change regularly.

Their limits are as important as what they permit:

• No passport. An offshore licence gives no right to serve clients in the EU, the UK, Switzerland, Singapore or Hong Kong. Each of those markets requires local authorisation or a recognised exemption.
• Reverse solicitation is narrow. Under MiFID II Article 42, a third-country firm may act without EU authorisation only when an EU client approaches it at the client’s own exclusive initiative. ESMA has stated that any solicitation, promotion or advertising in the EU takes the firm outside this exemption. This applies regardless of contractual clauses or online “I agree” boxes claiming the client came of its own accord.
• Marketing is itself regulated. The SFC Licensing Handbook states that it is a serious offence to actively market regulated services to the Hong Kong public without a licence. Similar rules apply in most major markets, and regulators publish warning lists of firms that breach them.
• Banking and payments. Banks, card acquirers and payment institutions assess where a broker’s clients are located, not only where its licence was issued. A broker whose client base does not match its licences can lose access to client money accounts and payment rails.
• Investor protection gaps. Retail leverage caps, negative balance protection and compensation schemes that apply in the EU and UK may not exist or may be weaker. Institutional counterparties and liquidity providers take this into account in their due diligence.

For a group, the practical model is often a regulated entity in each core market plus an offshore entity for clients in markets where no local regime applies. Each entity then needs its own substance, governance and onboarding controls that keep clients in the correct entity.

Hong Kong: SFC Type 3 leveraged foreign exchange trading

Hong Kong is one of the few major centres with a dedicated licence for retail leveraged FX. Under the Securities and Futures Ordinance, non-bank firms in the retail leveraged FX market must be licensed by the Securities and Futures Commission for Type 3 regulated activity. Banks are supervised separately by the HKMA.

The SFC Licensing Handbook sets the following financial resources requirements for Type 3:

Type 3 licensed corporation	Minimum paid-up share capital	Minimum liquid capital
Approved introducing agent	HKD 5,000,000	HKD 3,000,000
Any other case	HKD 30,000,000	HKD 15,000,000

These figures are high compared with most other SFC regulated activities, which partly explains why the number of Type 3 dealers is small. Where a firm applies for several regulated activities, the highest applicable capital requirement applies.

Other key points from the Handbook:

• Responsible officers: the firm needs at least two responsible officers for each regulated activity, one of whom is an executive director. Not having two qualified responsible officers is a listed reason for applications to be returned.
• Processing time: a licensed corporation application normally takes about 15 weeks once complete. Time varies with the business model and the quality of the application.
• Competence: responsible officers and representatives must meet industry qualification, experience and local regulatory knowledge requirements.

Practical considerations for applicants

1. Define the business model first. Agency brokerage (no own account dealing, no client money) carries the lowest capital and the simplest prudential regime. Market making and client money holding move the firm to higher tiers.
2. Plan capital for the fixed overheads test. A realistic budget, including staff, technology and outsourcing, drives the ongoing requirement more than the initial capital figure.
3. Map target markets before choosing a licence. Where clients are located determines which authorisations are needed. The licence location does not change that.
4. Expect product rules to shape revenue. Leverage caps, negative balance protection and bans on incentives reduce retail trading volumes. Business plans should be built on these rules, not on offshore leverage levels.
5. Prepare for scrutiny of client money and banking. Regulators and banks will examine segregation, reconciliation and the source of client funds from the first day.

Summary

Investment firm licensing is driven by services, client assets and own account risk. In the EU and UK, capital tiers of 75,000, 150,000 and 750,000 in euro or sterling set the entry point, while fixed overheads and K-factors set the ongoing requirement. Retail leveraged products face harmonised leverage and loss protection rules in Europe and margin rules in Asia. Offshore licences are legitimate for their own markets but do not open regulated markets elsewhere. Hong Kong’s Type 3 regime shows how a major centre treats retail FX as a specialist, highly capitalised activity.