Advertisement
Advertisement

Forex Brokers Regulations

By:
Carolane De Palmas

Selecting the right broker starts by checking that it is truly licensed, regulated and authorized where you live. In addition to a broker’s regulatory status, you need to know which regulatory body it be-longs to, as they do not all follow the same kind of regulations or offer the same type of financial protection.

Forex Brokers Regulations

One of the biggest risks when using Forex brokers that aren’t under regulatory supervision is that they don’t have to conform to any established standards, and so unethical – or even illegal – behavior cannot be ruled out. Worse, should something happen, there is often no way to take legal action against them.

Forex broker regulations are thus essential – they ensure that you’re trading with a broker that adheres to standard business norms, acts in your best interests, and offers some manner of financial protection.

Selecting the right broker starts by checking that it is truly licensed, regulated and authorized where you live. In addition to a broker’s regulatory status, you need to know which regulatory body it belongs to, as they do not all follow the same kind of regulations or offer the same type of financial protection.


Regulations by Geography


Regulators around the world have tightened regulations to protect traders in recent years, with increased oversight from regulatory bodies such as the SEC in the US, the FSA in the UK and the CySEC in Europe. Typically, Forex brokers are required to deal with top-tier financial institutions and liquidity providers, as well as to keep their client funds in separate accounts. FX brokers also need to meet certain other criteria, such as capital and fiscal requirements.

In Europe

In light of the vast number of Forex & CFD brokers that are regulated by European regulatory bodies, we’ll start our overview from there.

There are many local regulatory bodies in the European Union, such as:

  • Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) in Germany,
  • Swiss Financial Market Supervisory Authority (FINMA) in Switzerland,
  • Finanstilsynet (FSA) in Denmark,
  • Autorité des Marchés Financiers (AMF) in France,
  • Comisión Nacional de Mercado de Valores (CNMV) in Spain,
  • Financial Market Authority (FMA) in Austria,
  • Comissão do Mercado de Valores Mobiliários (CMVM) in Portugal,
  • Malta Financial Services Authority (MFSA) in Malta.

Members of the European Union, under the supervision of the MiFID directive – which we talk about later – are allowed to “passport” an authorization received from a European regulatory body, to be allowed to operate legally within the European Union (EU) as well as within the European Economic Area (EEA).

One of the most attractive regions in Europe to set up a forex company is Cyprus, due to its advantageous fiscal and tax structure.

So, if a financial company decides to set up shop in Cyprus, it will be registered, licensed, authorized and operate under the Cyprus Securities and Exchanged Commission (CySEC), which monitors the financial markets with the support of the European regulatory authorities and the European Commission to protect traders.

But this company would also be able to legally offer its financial services in other countries in the EU and the EEA, and it will be registered in every local European regulatory body.

To be a CySEC Forex broker, as of April 2019 a financial firm must follow certain rules, such as*:

  • An initial share capital of at least €200,000,
  • At least €750,000 in operating capital,
  • Submit regular financial statements, as well as yearly audit reports through certified independent third-party auditors,
  • Ensure the protection of clients funds by holding them in segregated accounts, and using top tier 1 banks and quality liquidity providers,
  • Adhere to the Investor Compensation Fund (ICF), which means that in case of bankruptcy, each client can recover up to €20,000.

To verify the authenticity of a CySEC regulated broker, always look for the 5 digit CySEC License Number (CIF) on the broker’s website:

Tickmill Group Licences and Regulationsulations
https://tickmill.com/about/licence-and-regulations/

Then verify the license on the CySEC website and make sure that the domain on CySEC website is the broker’s one:

Cyprus Securities and Exchange Commission
https://www.cysec.gov.cy/en-GB/entities/investment-firms/cypriot/74706/

Legislative Frameworks

MiFID II

Brokers following MiFID, the European Markets in financial instruments directive implemented in 2007 by the European Commission, must follow several rules:

  • Warn their clients about risks involved and categorize them (retail investors vs. professional investors),
  • Display their prices,
  • And act honestly towards their customers.

However, transparency in the financial markets did not improve following the establishment of MiFID, with the 2007-2008 financial crisis highlighting the lack of liquidity, settlement and delivery defaults, as well as the circumvention of the transparency principle through highly secret platforms, known as “dark pools”.

In light of these issues, the European Commission considered a revision of this regulation. MiFID II, which went into effect last year, thus aimed to address the grey areas in fast-growing OTC markets, particularly for derivative products. The direction also wants to work for better investor protection by ensuring that consumers have a clear understanding of the financial products in which they invest.

For instance, it is now necessary for a broker to assess a future client’s knowledge and risk profile before doing business with them. It is, therefore, a question of selling the right financial product to the right customer. To do this, a broker usually asks future clients a few questions about their personal and financial situations, but also about their knowledge of the financial markets and trading.

Brokers must also comply with procedures to be sure they know their clients and where the money used for trading comes from – Know Your Customer (KYC) and Anti-money laundering (AML) procedures.

To sum up, this new directive is supposed to enhance the transparency of regulated platforms, as well as of the financial markets, improving trader protection through better business conduct.

The European Securities and Markets Authority (ESMA)

Because of high leverage and margin trading, retail investors have lost a lot of money over the years on the Forex market trading CFDs.

The European Securities and Markets Authority (ESMA) recently decided to strengthen “restrictions on the marketing, distribution or sale of contracts for differences (CFDs) to retail clients”.

The restrictions for retail investors include:

  • A leverage limit of 30:1 for major currency pairs, 20:1 for non-major currency pairs, and 2:1 for cryptocurrencies,
  • 50% margin closeout rule,
  • Negative balance protection,
  • Restriction about the incentives offered by brokers to trade CFDs,
  • Standardization of a risk warning showing the average retail investor’s percentage of losses on CFDs accounts.

On March 27th 2019, the ESMA decided to renew these restrictions on CFDs for another 3 months from May 1st, 2019.

As the UK is still in the European Union until at least April 12th, this means that UK firms must comply with ESMA’s decisions and measures until then. However, the FCA Forex regulation could change, as it declared that it “expects to consult on whether to apply these measures on a permanent basis to UK firms providing CFDs to retail clients.”

The ESMA is constantly publishing updates linked to the Brexit situation and the recognition of UK central counterparties (CCPs) like LCH Limited, ICE Clear Europe Limited and LME Clear Limited, and Central Securities Depository (CSD) like Euroclear UK and Ireland Limited.

In the UK

According to the BIS Triennial Central Bank Survey 2016, the UK hosts the most important sales desk in the world, via its trading hub in London. It alone processes 36.9% of global OTC Forex turnover.

In order to prevent broker scams, financial malpractice or other types of fraud affecting traders, there are 2 important financial regulatory bodies in the UK, the FCA and the PRA.

To be able to undertake financial services activities in the UK, a broker needs to be authorized by the Financial Conduct Authority (FCA). This national regulatory body ensures consumer protection while guaranteeing the integrity of the financial markets in the UK

The Prudential Regulation Authority (PRA), which belongs to the Bank of England, helps in developing ethical and professional standards to protect the financial firms it is responsible for, so that in the case of a failing financial firm, there is no real impact to the financial markets or the taxpayers.

Of course, these institutions work with other bodies, such as the Financial Ombudsman Service, the Money Advice Service, the Payment System Regulator, and the Financial Services Compensation Scheme among others.

To be an FCA Forex broker, a broker should adhere to strict guidelines, such as:

  • Having at least £1,000,000 in operating capital,
  • Submitting audit reports and financial statements,
  • Ensuring the protection of client financial funds with the Financial Services Compensation Scheme (FSCS). This scheme is about protecting clients in case of bankruptcy of insolvency. If an investment firm failed between January 2010 and Mar 31st 2019, a client can ask for £50,000. If it failed after April 1st, you could be compensated up to £85,000.

In the USA

With 19.5% of global OTC FX turnover, the United States is the world’s 2nd most important sales desk. To regulate the Forex markets, and other derivative and OTC markets, there are 2 main regulatory bodies, the NFA and the CFTC, who work together.

The National Futures Association (NFA) helps investors to be more protected. The NFA also works to ensure its members respect their regulatory responsibilities for better market integrity, fighting scams and fraud through best financial practices.

The NFA also works with the Commodity Futures Trading Commission (CFTC). Together, they fight systemic risk, and ensure traders of the quality and reliability of Forex firms regulated by them.

In 2010, the CFTC issued regulations. Among those, the leverage used by retail trades was limited to:

  • 1:50 for major currency pairs,
  • and 1:20 for all other pairs.

To be an NFA and CFTC FX broker, a broker must follow the below rules:

  • Follow safe and transparent best market practices:
    • hire knowledgeable and professional staff,
    • use real facts and numbers in advertising and promotional materials without misleading traders,
    • submit reports and financial statements that are later on published on the NFA website,
    • follow the FIFO rule (first in, first out),
    • never open positions against its clients,
    • never allow hedging for traders,
    • offer a leverage effect of 50:1 maximum,
  • Keep client funds in segregated accounts,
  • Have at least $20,000,000 in operating capital.

In Australia

The Australian Securities & Investments Commission (ASIC) is the main regulatory body supervising the securities and investment market in Australia. It works with various regulators and organisations in protecting consumers and investors.

For instance, ASIC works with the Australian Prudential Regulations Authority (APRA), which supervises financial institutions to maintain the safety of financial institutions.

To be able to conduct financial service activities in Australia, brokers are required to have an Australian Financial Services (AFS) licence. As an ASIC Forex broker, certain criteria must be followed:

  • At least AUD 1,000,000 in operating capital,
  • A representative office in Australia,
  • Must comply with the organizational competence obligation in s912A(1)(e) of the Corporations Act 2001 (Corporations Act),
  • Adhere to a professional indemnity (PI) insurance cover,
  • Total financial transparency, with the submission of periodic audit reports,
  • Work with tier-1 banks, keeping client funds in segregated accounts.

In South Africa

Regulation in the financial sector in South Africa was maintained by the Financial Service Board (FSB) but it is now in the hands of the Financial Sector Conduct Authority (FSCA). The core mission of these regulatory bodies is to protect investors from losing money through scams and fraud thanks to a safer, more transparent and reputable trading environment.

The FSCA is quite new. It was created in April 2018, as “the start of a new, more holistic and intensive approach to regulating the conduct of financial institutions operating in South Africa – focusing on how they treat financial customers and on how they support the efficiency and integrity of the financial markets”.

Conclusion

The Forex market is one of the most volatile markets in the world. This highly leveraged market is also an unregulated market, with no real international regulatory body that monitors currency trading world-wide.

However, we’ve seen that there are national regulatory authorities that are working on protecting Forex investors. In addition, a Foreign Exchange Working Group (FXWG) was created in 2015 to provide global good practices for the FX market. In May 2017, this group published an FX Global Code to provide a set of guidelines to promote market integrity and protect traders against large losses, scams or other financial manipulation.

It is therefore essential that before investing real money on the Forex market with a specific broker, you check its regulated status.

In Europe, for instance, you can make sure the broker you want to make business with is regulated and authorized to provide investment services by an EU regulator on the ESMA website. In addition, each country’s regulatory body keeps a record of all the firms it regulates.

The ESMA also keeps a list of companies (or persons) that offer (or are suspected to offer) services without proper authorization. More details about these companies/persons can be found on the websites of the regulators. There is also the International Organization of Securities Commissions (IOSCO) website, which ggathers alerts and warnings from the IOSCO’s members in its “Investor Alerts Portal”.

Choosing a broker that is regulated in one place is good, but it’s always best to pick one that is regulated in several countries. For instance, Tickmill is registered in three different places – firstly, as a Securities Dealer by the Seychelles Financial Services Authority (with the FCA via Tickmill Ltd), secondly, by the UK FCA via Tickmill UK Ltd, and thirdly, by the CySEC as a CIF limited company, via Tickmill Europe Ltd.

About the Author

Carolane graduated with a Masters in Corporate Finance & Financial Markets and got the AMF Certification (Financial Markets Regulator in France). Afterward, she became an independent trader, investing mostly in European and American stocks/indices.

Did you find this article useful?

Advertisement