Chapter 10. Forex Regulation and Protection

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So, you want to get into Forex trading? Before you open a Forex trading account and fund it, check the regulatory status of your broker to find out if and where it is licensed and authorised. Regulation is a very important part of trading.

As we’ve already established, Forex is an OTC and not an exchange-traded market. This provides lots of benefits but by not having a central exchange it potentially removes some of the oversight needed for the market to be fair and not abused.

This is where regulators come in – OTC markets, especially retail OTC markets, need good regulation to police it. The regulator needs to strike a balance between letting the free market trade and protecting the small guy from unfair practices. 

In any case, you need to work with a trustworthy, well regulated Forex broker that looks after your money, has fair market practices, doesn’t mislead you in its marketing and has enough capital to stand behind its commitments to you.

Usually, brokers display on their websites by whom it is regulated, and a risk warning that should be standardised within all European countries according to new ESMA rules.

Client classification

In developed Financial industries, there are different rules for different types of participant. In the UK anyone participating in financial services is classified as one of the following:

  • Eligible counterparties – these are institutions that really understand the risks they are taking on. These would be banks, big hedge funds, big investment managers, governments, central banks – those sorts of participants.
  • Professional clients – these are businesses or individuals that are not huge institutions or experts. However, they are experienced in what they are doing and understand the risks. Sophisticated private traders, with significant resources, would fall into this category.
  • Retail clients – this is everyone else that isn’t an eligible counterparty or a professional client. Most private traders fall into this category.

The reason for the categorisation is different financial regulations are applied to different categories of client. Protections for retail traders are a lot greater than for professional traders, which in turn are greater than those for eligible counterparties. 

Unless you are very experienced and have significant resources, you will be a retail trader by default – this means you’ll be afforded the highest levels of protection on offer, but also accept some limitations on the products and services you can use.

Retail vs professional Forex traders
These classifications mainly impact Forex traders trading with a UK regulated broker in the following ways:

 RetailProfessional
LeverageCappedUncapped
IncentivesNoYes
Complex productsNoYes
Negative balance protectionYesNo
Segregated client fundsYesNo
Access to Financial OmbudsmanYesNo
Access to FSCSYesNo

Who regulates the Forex markets?

All countries differ in their approach to regulating Forex trading. There is no global agency overseeing the global Foreign Exchange market, there are national authorities that regulate that country’s Financial Services sector, such as:

  • Autorité des Marchés Financiers (AMF) in France
  • Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) in Germany
  • Comisión Nacional de Mercado de Valores (CNMV) in Spain
  • Financial Conduct Authority (FCA) in the U.K
  • European Securities and Markets Authority (ESMA) for the European Union
  • U.S. Securities and Exchange Commission (SEC) in the U.S.A
  • Australian Securities Investments Commission (ASIC) in Australia

In 2015, the Foreign Exchange Working Group (FXWG) was created to work on global principles of good practises for the FX markets, which led to the May 2017 publication of a global code of conduct for wholesale foreign exchange markets.

The Bank of England belongs to the 16 member institutions that signed up to FX Global Code and helped to work on a further harmonised Forex industry, and better global protection of retails consumers trading the Forex market.

Read: What is the Legal Age to Trade Forex?

Forex regulation in the UK and Europe

According to the BIS Triennial Central Bank Survey 2016, London is the most important sale desk in the world. The United Kingdom gathered 36.9% of the global OTC Foreign Exchange turnover between April 2013 and April 2016.

In the U.K., there are 2 main financial regulatory bodies:

Financial Conduct Authority
The FCA, which describes itself as “the conduct regulator for 58,000 financial services firms and financial markets in the U.K.”, helping to protect consumers.

Prudential Regulation Authority
The PRA, which belongs to the Bank of England (BoE) works at ensuring the health and safety of the 1,700 financial firms that it is responsible for.

These two primary institutions also work with different bodies, such as:

European Securities and Markets Authority

Due in part to the increasing use of leverage by retail traders and aggressive marketing practices in the EU by brokers, in 2018 ESMA decided to intervene to prohibit binary options and restrict the use of Contracts for Difference (CFDs), these changes extended to rolling spot Forex and financial spread bets.

ESMA rules
These rules impacted Retail Forex traders (not professional clients) as follows:

  • Limiting the leverage used by retail traders to 30:1 for major currency pairs, 20:1 for non-major currency pairs, and 2:1 for cryptocurrencies.
  • Automatically applying a 50% margin close out rule on a per-account basis.
  • Negative balance protection on an account was made mandatory.
  • And prohibiting all monetary/non-monetary benefits offered – this meant account opening bonuses were banned.

ESMA oversees all Financial Services business in Europe, and most country regulators, like the FCA, adopted the measures.  

Forex regulation in the USA

After the United Kingdom, the United States is the 2nd most important sales desk, with 19.5% of the global OTC Foreign Exchange turnover between April 2013 and April 2016. CFDs and spread bets are banned for retail traders in the US, so spot Forex is very popular and tightly regulated.

There are 2 main obligatory regulating organisations for Forex brokers in the USA:

  • The National Futures Association (NFA), whose main goals are to protect investors from scams and fraud, to preserve the integrity of the derivatives markets, and to ensure that its members respect their regulatory responsibilities, and
  • The Commodity Futures Trading Commission (CFTC), that works at avoiding systemic risk, and helping traders to determine if the Forex firms they want to use are reliable.

Forex leverage caps in the US
In 2010, the CFTC issued regulations, which limited the level of leverage allowed for retail consumers to:

  • 1:50 for major currency pairs
  • And 1:20 for all other pairs

There is also the Foreign Exchange Committee (FXC), sponsored by the Federal Reserve Bank of New York. They have been working on guidance to Foreign currency trading since 1978.

 

How this impacts you

The regulator’s job is to regulate the brokers, it is not there to tell the citizens of that country where they can trade, that is the individual’s decision. For time immemorial it was assumed the citizens of a particular country would naturally choose to use a broker from that country – then came the internet which allows traders to use brokers from other jurisdictions. The regulatory environment is still adapting to this seismic shift in how business is done. 

Each trader will have their own requirements, so it is important each trader does their own research around the risks and benefits of a particular jurisdiction or broker.

If the capped leverage is not a concern, then EU traders tend to gravitate towards an FCA broker. Outside the EU, and the US, traders either trade with a broker in their own jurisdiction, or if that is less developed, gravitate towards an ASIC regulated broker.

It is an important decision, so don’t click on the first shiny banner advert promising 1000x leverage, take your time and place regulatory protections at the top of the criteria you use to choose your broker.

There is no one size fits all – what might be great for a new trader might not work for an experienced trader. The good news is it is a big competitive industry with lots of brokers to choose from.

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