Online Trading For Expats
by the InvestorsOffshore Editorial Team, August, 2011

IMPORTANT WARNING: The contents of this article and the attached report have been compiled in good faith by Investorsoffshore.com to provide assistance to investors, but do not constitute investment advice or recommendations. Investors should not rely upon the information given in order to choose types or routes of investment but should make their own independent enquiries before making choices. Investorsoffshore.com has taken reasonable care in researching and presenting the information herein but makes no representations as to its accuracy and accepts no liability for actions taken or not taken as a result.

For the domestic investor, the choice of online brokers seems almost endless; for the expat, whose somewhat unusual situation allows for a greater flexibility of investment choice and possible advantages in terms of taxation, the choice seems to be less broad, but is growing by the minute, as onshore brokerages recognise the potential of the expanding 'globetrotting' mass affluent market, and brokers in low-tax jurisdictions recognise the need to provide their clients with up-to-the-minute facilities.

Many 'offshore' brokerages now offer facilities for trading in an extremely wide range of instruments, including tax-exempt trading on most stock exchanges around the world, and some or even all of: futures, options, forex, bullion, commodities, CFDs, silver, treasury and investment-grade corporate bonds, bank CDs, unit trusts, ISAs, ETFs and even individual funds.

Offshore brokerage accounts are now usually conducted through secure multicurrency platforms which can be accessed online or by email, fax or phone. Many brokers provide clients with research, analytical and charting facilities.

Country-specific online brokerages should not be completely ruled out, as it may be that the trading account that you opened in one country can still be accessed and traded from another. Residential information is asked for when opening an account, but is often not checked every time an investor logs on. Information about residence and eligibility can usually be found on a company's website, or through a customer service representative, but if in doubt, you should seek professional advice. But the facilities available through domestic brokerages tend to be more limited, both in terms of markets available and riskiness, mostly for regulatory reasons. This may provide the investor with an overarching 'umbrella' of support if things go wrong, but at the same time, means that potentially more profitable avenues can be closed to her.

Offshore investment, and by extension, offshore brokers, reap the benefits of less restrictive regulatory regimes in many cases, and can therefore, at least theoretically, provide the internationally minded investor with a broader and more interesting range of investment options. In some cases the reality hardly matches up to expectations at present, but this is changing rapidly as brokerages compete on the international market.

Using a broker in a low-tax jurisdiction can also be advantageous in taxation terms, depending on your personal circumstances. Some types of security give better tax performance when bought offshore. By using an offshore broker, you may also be able to escape stamp duty in those countries that still apply it. Many shares however are listed on high-tax country stock exchanges, and dividends are often paid out of taxed income in the country of main listing, or are subject to withholding tax. So wherever you are, you are unlikely to be able to receive dividends gross.

A word of especial warning in relation to the USA: for many years, investors, whether US citizens or otherwise, have used offshore brokerages to trade US stocks and other financial assets, either directly in their own name or through an offshore trust or foundation. As part of President Obama's attack on 'offshore', there are numerous pieces of legislation, some enacted and some still in process, which are making this technique much less attractive, especially for US citizens.

In particular, the FATCA rules (Foreign Account Tax Compliance Act) included in the Hiring Incentives to Restore Employment (HIRE) Act of March 2010 will tilt the playing field towards the IRS quite significantly when they come into force in 2012. Its provisions include: 30% withholding on US source payments to foreign financial institutions, foreign trusts, and foreign corporations that do not agree to disclose their US account holders and owners to the IRS; requiring taxpayers to disclose their foreign accounts on their US tax returns; increasing the statute of limitations to six years for failure to report certain offshore transactions and income; clarifying when a foreign trust is considered to have a US beneficiary; and treating substitute dividend and dividend equivalent payments to foreign persons as dividends for purposes of US withholding.

Despite the IRS, perhaps you are still sold on the idea of an offshore broker? There are a number of good offshore brokers out there in a variety of jurisdictions that will be able to cater to your needs, hopefully consulting with you if that's what you want, and tailoring investments to your openness to risk and eventual goals (i.e. do you want to retire to a sandy beach somewhere on your investment income, raise capital to start the newt breeding farm you've always dreamed about, or just make pots of money…?) But if you want to get in there and do it for yourself, you can, just as much as you can with an onshore e-brokerage.

A note of caution, however. Full service brokers, whether onshore or off, provide a level of support, advice, and, well…service that by definition is not available from a pure internet brokerage. The medium does not easily allow for the same kind of personal relationship that can be built with a traditional broker, and while the online broker may possess exactly the same level of expertise and background knowledge as a good full service broker, this is less easily imparted by a website, no matter how many bells and whistles it may have.

Good offshore brokers, though, have always maintained a more interactive relationship with clients, tailoring investments to meet their residential needs and eventual goals, and this ethos seems to have filtered down to the e-brokers, meaning that they have suffered less than domestic online brokers from accusations of facelessness and impersonality. This is perhaps also linked to the fact that many of the offshore brokerages have grown up in association with private banking and wealth management services.

So if you feel that at the moment, your knowledge is too limited to invest without substantial back up, or you are particularly sensitive to risk, it may be best to look for a full service broker, whether onshore or offshore. Selecting an offshore full-service brokerage does not mean that you will be retreating to the technological dark ages, as the vast majority of offshore brokers are web-enabled in some way, with facilities which allow you to conduct research, monitor your portfolio online, or at the very least communicate with your advisor by e-mail.

However, if you have a thorough working knowledge of international investing, and feel ready for self-directed investment, then an offshore or international online trading account may be for you. When choosing an online broker, there are many issues to be addressed, and here we will go into some of the main areas of specific interest to expatriate investors thinking of trading online:

• Range of investments: Although, as previously mentioned, most offshore online brokers offer a range of listed and unlisted equities and US and offshore mutual funds, it is worth shopping around, as the choice and quality of investment options can vary. Some offshore brokers can provide you with access to securities on markets other than the US markets, and others offer the more experienced investor other investment instruments such as futures and options, or the chance to invest in Initial Public Offerings (IPOs).
  
• Hours of Trading: As an expat, this may be an area which concerns you more than it would do a domestic investor trading online via a country-specific broker. If you are frequently on the move, you may need to order trades outside of normal market hours. Many brokers, both onshore and off, have picked up on this, and are making use of Electronic Crossing Networks (ECNs) in order to offer extended hours trading to their clients.

ECNs are computerised trading networks or markets used to display and execute limit orders, and in a very real sense, they bring the exchange to the user. Participants submit their orders, and matched orders are executed at the mid-point of the bid-ask spread. Electronic Crossing Networks such as Archipelago, BATS ECN, Brut, Direct Edge ECN, Instinet, Liquidnet, NYPPex, Pipeline, Posit, SIGMA X and Track ECN have become an entrenched part of the investment landscape, and the fact that they provide low cost execution and anonymous, direct access to the markets, as well as more flexible trading hours than the legacy exchanges means that their popularity with online brokers continues to increase. At the top end, in terms of volume traded, it is the ECNs which have led to the development of the notorious 'dark pools' of trading and liquidity which make regulators nervous, since they are not transparent. US broker Rosenblatt Securities said in a report on US dark trading earlier this year that dark pool transactions made up 13.27% of US equities trading volume at the end of 2010, up from 10.15% at the end of 2009. Rosenblatt predicts that dark trading will reach 15% by the end of 2011.

As usual, however, there are risks, and it is important to at least be aware of these before deciding whether you would prefer to establish an account with an offshore broker offering extended hours trading. During standard market hours, trading takes place on a variety of exchanges, as well as through market makers and ECNs, but during extended hours sessions, all orders are processed through the designated ECN (if they are processed at all), which if it is part of a trading network, may also offer access to prices available on other participating ECNs, but will not necessarily do so.

There are also limitations imposed on the type, size and time limits of orders which can be placed during extended hours sessions; most ECNs will only accept limit orders; there is usually an upper limit on the size of the order; and not all security types are available outside of standard trading hours - often just NYSE and NASDAQ securities. Generally, the lower level of trading activity characteristic of an ECN may result in lower likelihood of trade execution, wider spreads, and greater price fluctuation.

Perhaps partly due to these risks, and also because of their status as relative newcomers, the vast majority of Electronic Crossing Networks do not yet allow individual investors to trade with them directly, and at the moment, they can only be accessed through brokerages offering extended hours trading. This may change in future, however, as several of the networks have moved towards making their services available to retail investors.

Recently, direct access trading has emerged, allowing investors to cut out the middle man and trade directly with market makers across high-speed computer networks, which has the advantage of speed of execution and, as a consequence, ensures that the trader more often gets best price; even online brokers, particularly those aimed at novice traders, can at times suffer from painfully slow order execution. However, direct access trading costs can soon mount up, and traders can be expected to pay DAT firms commission, as well as numerous other fees, such as software fees, and account inactivity fees if the user’s trading activity falls below a set level. Another thing to consider is that by removing the broker from the equation, DAT users are effectively fending for themselves and this form of trading is only recommended for the serious and trader with the requisite level of expertise (and money!).

Regardless of whether you choose to work through a domestic brokerage or an offshore one, it is essential to carry out very thorough due diligence in advance. While the brokerage will definitely be applying KYC (Know Your Customer) rules to you, it is important that you apply KYB (Know Your Brokerage) rules to them.

• Commissions and Fees: When choosing a broker, as with any service, it is always wise to compare commissions and fees - some may charge a percentage per trade, while others have a standardised minimum fee per transaction, and the amount can vary. Also, look for 'hidden' charges, such as account opening and administration charges, and bear in mind that some online brokers may charge for additional facilities (such as checking or quotes) that are offered free elsewhere.
  
• Account Type: Consider the type of account that you will need, as some (but not all) offshore online brokers offer margin accounts, which essentially means that you do not need to have the full amount in your trading account in order to make a trade - the broker will make you a loan, using securities already held in your account as collateral. You will usually have to sign a separate agreement for this, and obviously investing with borrowed money is more risky if things go wrong, but the obvious advantage is that with a margin account, if you need to, you are able to leverage purchases and buy a greater amount of stock.
  
• Execution and Settlement: You should also look into efficiency of execution, and the timing of settlement after a trade has been executed. Where trades are processed electronically, execution time can be a matter of seconds, but with brokers that do not offer extended hours trading, an order placed outside of standard market hours will remain pending until the markets open again. For settlement, the industry standard at the time of writing is T+3 (or three business days after trade execution), but many brokers require that the full amount needed is in your trading account prior to placing the order, so it is always best to check. The majority of offshore online brokerage accounts at present are denominated in US dollars, although some do accept deposits in other currencies which will then be converted, but again, if you have specific currency requirements, you should be able to find something to suit if you shop around.
  
• Solidity: In the course of researching for this special report, two distinct types of offshore online brokerages emerged - those that are subsidiaries of, or online services offered by, traditional full service brokers, and those that are standalone services, established with the express purpose of offering international online trading. Once again, which of these you prefer comes down to personal choice. You may feel more comfortable trading with an organisation whose name you know, and who has a history of providing financial service, or you may want to take advantage of the fact that a newer company may be more flexible, and able to provide newer and more technologically advanced services because their main and only focus is online trading. It is really a matter for you to decide, and once again, it is recommended that you take decisions of this nature with the advice of a qualified professional. However, whichever way you decide, always make sure that there are investor protection measures in place, so that your assets are cushioned should anything untoward happen (other than fluctuations in the market, of course!)
  
• Residential Restrictions: The offshore brokers that exist are located in a variety of different jurisdictions (at the moment, there seems to be a bias towards the Caribbean, but this may change in the future). It is worth considering, in terms of your personal circumstances (i.e. nationality, country of tax residence, and investment requirements) which jurisdiction is best suited to your needs. Many online brokerages place residential restrictions on the use of their services, and at the moment, citizens and residents of the United States in particular are poorly served, due to the comprehensive and restrictive nature of US taxation and regulation.

As you can see, then, there are many points to be considered before you can make a final decision about which offshore online broker is suitable for you. The InvestorsOffshore Services Directory offers details for a number of prominent offshore brokerages such as FINANCIAL PACIFIC at http://www.investorsoffshore.com/html/plazas/plaza_equity.html, but please note that inclusion on the plaza does not imply any approval or recommendation on our part. It is essential that you do your own due diligence on your brokerage of choice, as described above.