A Beginner’s Guide to Forex Regulation

A Beginner’s Guide to Forex Regulation

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If you have decided to open a forex trading account, it is not possible to overemphasize the significance of trading with a broker with a proper Forex Regulation that follows the rules governing financial markets. Regulated status forces forces  brokerage companies to provide an essential layer of protection to both the company and their clients real-time.

Typically, forex regulation requires brokerage firms to keep customer funds separated from the company’s operating capital, to prevent rogue firms from embezzling customer money or using customer funds to pay operating costs. Many unregulated brokers don’t undertake necessary measures to protect customer funds and often do not comply with this simple rule. In these cases, clients can experience delays in withdrawing their funds – more than 3 months in some extreme cases.

In this piece, we lay out the current regulatory framework in various regions and give some comparisons

  1. Forex and CFD Regulation in Europe:

Regulation of financial services in Europe is conducted at the national level by domestic regulatory bodies like United Kingdom’s Financial Conduct Authority (FCA), the Cypriot Securities and Exchange Commission (CySEC), Germany’s tongue-twisting Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin in short), and many others.

Although every European country has its regulator to oversee their national markets, there are also supranational regulatory bodies that conduct affairs on a regional level. Representatives of European regulators include:

  •  European Central Bank (ECB)
  •  European Banking Authority (EBA)
  •  European Securities and Markets Authority (ESMA)
  •  Switzerland, even though not part of the EU has its regulatory body: FINMA.

You will often see brokers and other financial service providers advertising themselves as EU Regulated companies, however there is no overarching European financial regulator that supersedes all the others although broad agreements are reached through so-called MoU’s and LOI’s expressing how agencies intend to co-operate with one another on critical issues relating to financial services transacting between applicable nations.

An example of this kind of co-operation is the MoU signed between the CFTC and more than 20 EU-based agencies in 2013, to better coordinate regulatory activities between the US and Europe.

Such co-operative agreements are becoming increasingly popular due to the evolving nature of modern markets which are turning ever more online-based, therefore making cross-border investment more straightforward to conduct and more complicated to monitor. Currently, all UK brokers are regulated by the FCA, Cypriot brokers by CySEC and each EU-based firm by its national regulator. Some reputable brokers regulated by these authorities include:

What links all these national regulators together is the Markets in Financial Instruments Directive which is popularly known as MiFID. What is MiFID?

 MiFID Introduction

MiFID stands for Markets in Financial Instruments Directive. It has been applicable all over the EU since November 2007, and it remains a cornerstone of the EU’s regulatory device, aimed at promoting financial markets’ competitiveness within the EU via a single market.

The EU’s ultimate idea is to unite and harmonize as much European legislation as possible with the final end-goal of managing and regulating the whole region through the ECB (000European Central Bank).

This task has been pretty difficult to achieve ever since the forging of the EU, and the Euro back in 1999 – most of the difficulties have come from the deep-rooted socio-economic, cultural and political differences between the 27 member states of the EU.

The MiFID is an excellent example of the EU’s devotion to a ‘common market’ for financial services. The main idea is to give companies in one country the opportunity to do business in any other in the European Economic Area. This is what the UK has signed up to “Brexit” in 2016, and continues to loiter in executing its exit strategy – mainly because the UK’s City of London is the most gravitational financial services hub on the world.

One of the primary tenets of the MiFID is that of outbound passport. When brokers say that they are EU regulated, it means that such brokers are regulated in a country which is signed up to the MiFID. This allows for brokers regulated in a country in the European Economic Area (EEA) to then offer their services to consumers throughout the EEA. Therefore, it is possible for a brokerage regulated in Cyprus to accept UK-based clients without having to obtain an additional regulatory license in the United Kingdom.

This is partly why some of the biggest names in retail forex, prefer to operate a European subsidiary which lets them promote their services to 500+ million residents.

Despite the fact that a broker regulated in one EEA states can do business all over the European Economic Area, the field of Forex regulation differs between member states with regulation in some regions being stricter than in others. This is because MiFID only strives for minimal harmonization, introducing a minimum level of law which must be adopted by domestic European regulators. This has seen some regulatory authorities go above the minimum requirements as set out by MiFID, while other countries have stuck very firmly to the bare minimums of MiFID’s requirements.

Many brokers prefer to operate from Cyprus, Bulgaria, and Malta which are all viewed as offering favorable regulatory environment from a broker’s perspective. MiFID outlines some significant protections for traders and has done a great deal to guarantee level playing fields amongst brokers based in the EEA.

One common protection policy introduced in MiFID is the initiation of mandatory investor settlement funds which protect retail clients should a broker go bankrupt, ensuring that deposited capital up to a certain amount is returned to the customer.

It also gives the minimum capital requirements and the compulsory segregation of customer and company funds, all of which provide traders with a level of significant protection.

 European Regulatory Authorities

As mentioned earlier, the Markets in Financial Instruments Directive (MiFID) applies to countries in the European Union and European Economic Area. Here is a list of all the nations and regulators covered by MiFID.

European Union Member States:

  • – Austria: Financial Market Authority (FMA)
  • – Bulgaria: Financial Supervision Commission of Bulgaria (FSC).
  • – Belgium: Banking Finance and Insurance Commission (CBFA)
  • – Croatia: Financial Services Supervisory Agency
  • – Czech Republic: Czech National Bank
  • – Cyprus: Cyprus Securities and Exchange Commission (CySEC).
  • – Denmark: Danish Financial Supervisory Authority (Danish FSA)
  • – Estonia: Finantsinspektsioon
  • – France: Autorite des Marches Financiers (AMF)
  • – Germany: Federal Financial Supervisory Authority (BaFin)
  • – Greece: Capital Market Commission
  • – Hungary: Hungarian Financial Supervisory Authority
  • – Ireland: Central Bank of Ireland (CBI) –
  • – Italy: Commissione Nazionale per le Società e la Borsa (CONSOB)
  • – Latvia: Financial and Capital Market Commission
  • – Lithuania: Securities Commission of the Republic of Lithuania.
  • – Luxembourg: Commission de Surveillance du Secteur Financier (CSSF)
  • – Malta: Malta Financial Services Authority (MFSA)
  • – Netherlands: Authority for the Financial Markets (AFM)
  • – Poland: Polish Financial Supervision Authority (KNF)
  • – Portugal: Portuguese Securities Market Commission (CMVM)
  • – Romania: Romanian National Securities Commission
  • – Slovenia: Securities Market Agency (ATVP)
  • – Spain: Comisión Nacional del Mercado de Valores (CNMV)
  • – Sweden: Financial Supervisory Authority of Sweden
  • – United Kingdom: Financial Conduct Authority (FCA)

European Economic Area:

Due to being members of the European Economic Area, these regulators are party to MiFID:

  • – Iceland: Icelandic Financial Supervisory Authority
  • – Liechtenstein: Financial Market Authority (Liechtenstein) (FMA)
  • – Norway: Financial Supervisory Authority of Norway
  1. Forex and CFD Regulation the USA:

The US regulatory body is considered one of the strictest in the world. Residents and citizens of the US are only allowed to operate with NFA and CTFC regulated brokers. Companies and individuals, who do not have the appropriate CTFC and NFA regulation, are not permitted to approach US citizens. This is why many websites emphasize a warning to visitors from the US, making them aware of the fact that the content of the site is not directed towards residents of the US.

Regulatory activities have grown dramatically since the initiation of the 2008 Dodd-Frank Act and forex brokers in the US have been on the receiving end of enormous restrictions.

Retail forex brokerage companies have been persecuted for the losses incurred by many traders, with severe leverage restrictions inflicted.

The NFA (National Futures Association) has reduced maximum leverage provided on retail trading accounts to as low as 50:1 leverage (in contrast to usual offerings of 500:1 – 1000:1 in the past) and services are only available to those who are considered eligible market participants.

Those who regulates foreign exchange in the US also place a huge of importance on transparency and therefore regulated forex brokers in USA are obligated to publicly release some data, including the number of accounts with the company and the profitability of the company’s clients.

While the United States regulatory body has formed a highly transparent and regulated marketplace, it has also made some brokers leave the US market as a result of lack of adequate funds to abide by suddenly steepened capital requirements put in place by the NFA. This implies that Us residents are more restricted when it comes to choosing regulated forex brokers in USA to trade with – and US residents have been opening FX/CFD accounts all over the world in flocks (usually without reporting the activity to the IRS and against the advice of the NFA). In light of the abovementioned, some of the reputable brokers fully licensed to provide services to US residents are Oanda and FOREX.com.

  • Forex and CFD Regulation Australia:

The regulation of retail forex has been in the hands of the Australian Securities and Investment Commission (ASIC) since 2006.  All brokerage firms operating in Australia must hold an ASIC license to receive client funds and offer brokerage services. The Australian regulator outlines a harsh list of standards for companies wanting to acquire an AFS license and operate within the country.

The requirements are very rigorous and ASIC is deemed to be doing a great job at protecting Australian customers from a regulatory point of view. With the inception of broadband internet and the ability of FX brokers to provide their services globally, however, it is now common to see Australian citizens creating FX accounts in various countries, and going against the advice given by ASIC.

This is because ASIC can only pursue complaints and claims against forex brokers based in Australia. Despite the official warning, thousands of Australians open accounts in Cyprus, UK and Europe and many are sadly disappointed if their broker fails to abide by market rules such as KYC, fair execution, capital segregation, etc. Some of the Notable ASIC-Regulated Brokers are Pepperstone, AvaTrade   and  VantageFX

New Zealand

Recent regulatory developments have seen the FMA crackdown on non-regulated bodies providing financial services such as CFD trading, FX trading, financial advice, and investment schemes. Working jointly with its significant neighbor, Australia, the Asia/Pacific pair operate in a close-handed manner on many issues like farming, mining, financial services, industry, employment and immigration law.

Due to the close co-operation, New Zealand’s reputation as a financial services center, including solid regulatory support, has now improved significantly.

Many years ago, several Forex CFD brokerage firms used to see New Zealand as a defacto stepping-stone into Australia, by basing operations in New Zealand but targeting Australian clients. Brokers were able to bypass many of the stringent rules set by its larger neighbor (ASIC)

Bringing in stronger regulatory requirements for both FMA regulated and FSP companies has been a remarkable shake-up of the industry, but by the same token, higher standards have seen many brokers leave the country.

The new requirements include:

  • Minimum net assets of 1,000,000 NZD or 10 percent of average revenue.
  • A management team responsible for regulation, compliance, and risk management.
  • Appropriate standards for the on-boarding of new customers.
  • Information on dealing policies and conflict of interest.
  • Standards for hedging internal risk and handling customer margin levels.
  • Rules for the segregation of customer funds.
  • Rules requiring companies to maintain a proper record of client account information.

Since NZ’s regulatory crackdown, many brokers have moved to regions with related regulator-arbitrage-potential – currently, there has been an increase in new registrations in Malta, Cyprus, Bulgaria and the UAE.

  1. Forex and CFD Regulation Russia:

Russian Association of Financial Markets, known as RAFFM is a Self-Regulatory Organisation. In Russia, and other CIS nations there is currently no regulatory body for the provision of some OTC financial services, like Spot Forex and CFD trading. RAFFM merely is one of the numerous Self-regulatory institutions which have been established to try and encourage clients when transacting with unregulated brokers who have a strong presence in the area.

RAFFM has just four member companies making it one of the smaller Self-regulatory organizations in the world, with other organizations like FMRRC and CFRIN having significantly more members. The organization doesn’t have the same sort of profile as other Self-regulatory organizations functioning in Eastern Europe, with CFRIN being seen as the regions premier self-regulatory organization and boasts high profile members like Alpari, FSB, and other top-tier Russian brokers.

However, RAFFM doesn’t have such an excellent reputation, with many criticising the usefulness and neutrality of the organization. Some have alleged that the four-member organizations all have links with one another, which would mean a severe conflict of interest should the allegations were true. It is possible for those who are clients with InstaForex, Mayzus Investment Services, CorsaCapital, and LiteForex to file complaints with RAFFM. This being said there doesn’t seem to be any instances of where investors have been able to resolve their problems by complaining to the organization.

Like other Self-regulatory bodies, RAFFM has no real power over its member companies with the organization not being able to fine or recover traders’ losses should a broker shut down. The main control the organization has over its members is the ability to withdraw their membership, but with these organization depending on membership revenues, they are often hesitant to kick out member firms.

Self-regulatory bodies like RAFFM, do not offer traders the same level of protection as governmental regulatory bodies. It is worth noting that some members of RAFFM, have particularly bad reputations with there being many complaints online about both LiteForex and InstaForex.

The era of Self-regulatory bodies may be soon coming to an end with the Russian government set to regulate the provision of forex and CFD trading in the country, which would put an end to firms basing themselves offshore and using Self-regulatory bodies to coffer legitimacy in the country.

  1. Forex and CFD Regulation Israel:

In the past few years the financial markets regulatory body in Israel, the ISA (Israeli Securities Authority) has solicited to bring Forex & CFD trading under its remit. There has been a long-running consideration that this kind of regulatory stance would finally come into force, and replicate what many other regulatory bodies have done all over the world.

The ISA set out to introduce additional measures directed at making retail trading ‘safer’, although this has been a difficult challenge for the ISA and other regulators. Binary options trading has been banned in Israel for any company applying to operate a licensed Trading Arena (online brokers). Trading FX CFDs has come under stringent restrictions, including limiting the range, leverage, and even how they calculate the rates.

The ISA’s strategy has been tagged by some as ‘draconian’ and overly strict despite the rapid growth of OTC (Over the Counter) derivatives, FX and CFD trading and an equal improvement in reporting through EMIR and MiFID.

The ISA’s changes have arguably had a negative impact on Israel’s retail trading industry, with many brokerage firms leaving and many Israeli residents greatly incentivized to create trading accounts abroad.

The ISA also banned the following trading instruments:

FTSE/MIB, IBEX 35, Hang Seng, and SPI 200 as well as EUR/HUF, EUR/TRY, TYR/JPY, USD/CZK, EUR/CZK, EUR/DKK, USD/TRY, USD/RUB USD/DKK, USD/HUF, and the USD/ZAR.

ISA claims the reason for the ban is ‘excessive volatility,’ and yet, it is high volatility that attracts most to traders looking at OTC markets like forex.

  1. Various Offshore Territories

You will find many brokers based in offshore locations such as the Cayman Islands, British Virgin Islands, Mauritius, and Seychelles. While some of these regions do in fact provide a framework for the regulation of forex, these jurisdictions are generally very soft on all facets of financial services regulations and oversight.

Conclusion

As regulation differs significantly from jurisdiction to jurisdiction, it is pretty difficult to cover all existing regulatory bodies and their slight differences adequately. Regulatory rules are also changing constantly, and persistently striving for positive development and a beneficial effect on broader market members.

In reality, regulatory authorities can move the goal posts and adjust the general rules governing markets – but this often has the effect of simply redirecting certain resources or funds from one set of market participants to another; but do little to ‘benefit’ some distinguished level of order in the financial markets.

If your country doesn’t appear on the above list, it is essential to research the state of regulation in your region before making any financial commitments.

Effective financial regulation gives traders extra peace of mind, and it is recommended that people only transact with brokers regulated in ‘reputable’ jurisdictions, namely: US, UK, EU, Switzerland, Cyprus, Japan, Singapore, Australia, Scandinavia, New Zealand. And it is worth noting that citizens of the countries listed above are likely to get favorable or more straightforward bureaucratic hurdles.