CySEC reveals new rules for fractional shares trading

The Cyprus financial regulator clarifies the conditions under which such investments can be considered direct shares under MiFID II.
The decision aims to clarify the regulations for CIFs that offer exposure to fractional shares.

The Cyprus Securities and Exchange Commission (CySEC) published new guidelines for investment firms that offer fractional shares, in response to the growing trend of online brokers that allow investors to purchase only small portions of listed shares.

The Cyprus regulator issues guidelines on fractional shares

In a circular published this week, CySEC set out the regulatory framework applicable to Cypriot investment firms that allow their clients to gain exposure to fractional shares through trust agreements. The decision comes as fractional investing has grown in popularity, particularly among retail investors looking to diversify their portfolios with smaller outlays.

"The Cyprus Securities and Exchange Commission has issued this circular to provide guidance on when fractional exposure to corporate shares, within the meaning of the Investment Services and Activities and Regulated Markets Law, implementing MiFID, would qualify as equity exposure as such," says the document signed by Dr. Theocharides, Chairman of CySEC.

The circular clarifies that where CIFs use trust arrangements to offer fractional beneficial ownership of shares, such investments will be treated as direct ownership of shares. This classification subjects the services to the same regulatory obligations as traditional stock trading, including the requirements of MiFID II and MiFIR.

The key points of the guidance are as follows:

- Trust arrangements should be properly documented and reflect the proportional ownership of clients in the CIF's records.
- Fraction owners should receive proportional rights, including voting rights and dividend distributions.
- CIFs must provide clients with clear and accurate information on the nature of fractional investments.
- The MiFIR equity trading obligation applies to fractional ownership through trusts.

The CySEC has stressed that financial instruments offering fractional exposure without a trust arrangement should not be presented as direct ownership of shares.

This clarification follows the European Securities and Markets Authority (ESMA) statement of April 2023 on derivatives based on fractional shares. The CySEC guidance complements ESMA's efforts by specifically addressing trust arrangements.

It is worth recalling that ESMA criticised fractional shares several months ago and suggested that they were misleading investors. The regulator stressed that fractional shares are a derivative instrument, which is not equivalent to corporate shares. Therefore, companies should not use the term "fractional shares" when promoting these products.

"All information provided to clients about these instruments must be fair, clear and not misleading and companies must clearly disclose all direct and indirect costs and fees related to these instruments," ESMA wrote in a press release in 2023.

The rise of fractional shares in investing
The rise of fractional shares has transformed the landscape of individual investing, despite concerns about regulation. The simplicity of the concept has driven its widespread adoption: investors can own a portion of the most expensive stocks, such as Tesla or Apple, even with limited capital.

Fidelity Investments, a major US brokerage with 22 million clients, launched fractional shares and ETF offerings 4 years ago. However, the trend had already begun months before, with firms like Interactive Brokers and Charles Schwab launching similar products to compete with Robinhood. The popular commission-free trading app was the first to offer the offering in late 2019, setting a new standard in the industry.

As the covid pandemic unfolded, more and more brokers embraced fractional share trading. FXCM introduced commission-free fractional share trading, followed by platforms like Skilling and BUX in the months that followed.