Every day new foreign exchange brokers enter the world’s largest financial market and engage in marketing activities to attract clients. Unregulated brokers enticing traders with attractive sign up bonuses significantly raise the risk of losses in forex trading. To help forex traders avoid scams, forex regulation is tightening as regulators close in on unregulated forex trading.
Many an investor has followed a link to a $500 sign-up bonus or no fee binary option trading only to later discover they have been duped. Because forex markets are global and decentralized, unregulated brokers often solicit clients in jurisdictions in which they are not authorized. Even if traders are profitable, they often confront payment restrictions processing their money or, an unfortunately common scenario, the operation shuts down before they can withdraw their winnings.
The regulation of forex varies from country to country. The best forex deals may not be eligible in your country. Rather than chase the highest bonuses, you can reduce your exposure to risk and fraud in the forex market by conducting due diligence and determine if your broker is regulated in your jurisdiction.
Advantages of Regulated Forex Brokers
Market regulation requires that foreign exchange brokers, investment banks and other market operators conduct business in compliance with the rules and regulations of the jurisdictions in which they do business. Regulated forex markets typically require brokers to register as licensed brokers.
Foreign exchange regulation requires licensed brokers to comply with the financial market rules and regulations of the respective jurisdiction. Compliance involves meeting capital adequacy and risk management standards among other market rules.
To ensure they conduct business in a compliant, fair and ethical manner, the regulated broker agrees to file regular reports and allow audits of their operations.
Regulation and enforcement measures, however, differ from country to country. The patchwork of regulations makes it easier for fraudulent brokers to set up online forex operations. Additionally, market manipulation, money laundering and other types of fraud are present in the foreign exchange markets.
Although regulatory action in the forex markets is severe and can range from fines to prison sentences—banks paid over $1 billion in market manipulation fines in 2018—online currency trading continues to be a target for unscrupulous activity.
Global Regulatory Trends
Regulatory trends in the top 8 foreign exchange markets by volume reveals regulators tightening forex regulation and making it harder for unregulated brokers to bend and break forex rules.
TradeFW is a good example of a regulated broker in Europe that has put prudent risk management measures in place while operating as a regulated broker in Cyprus, which has traditionally run a more liberal forex market. The Cyprus Securities and Exchange Commission (CySEC) is regarded as an innovator in forex regulation. As the first to regulate binary options, it has served as a gateway to the European market for binary option dealers. Under the new ESMA rules, a ban on binary options has been extended to January 2019.
The TradeFW leverage ratio is 1:30, in line with the industry move towards lower default leverage ratios. Negative balance protection, now mandated by ESMA, lowers traders downside risk.
United Kingdom – The financial conduct authority regulates forex broker licensing and regulations. Forex brokers must maintain capital requirements of $1 million and comply with Know your customer (KYC) and anti-moneylaundering (AML) requirements.
United States – In the United States the foreign exchange market is self-regulated by the National Futures Association (NFA), a registered futures association with the Commodity Futures Trade Commission (CFTC), which also regulates off-exchange retail forex, on-exchange futures, and OTC derivatives (swaps). Be aware of an increase in illegal operators targeting US residents. Binary options and CFDs can only be sold by US-regulated brokers.
Japan – The Japanese Financial Services Authority (FCA) oversees the retail forex market, which includes the largest over-the-counter forex market in the world. The leverage ratio has been gradually reduced. Regulators are seeking to reduce it from 25:1 to 10:1.
Singapore – Singapore’s low capital controls has made it an attractive financial center for foreign corporations and banks in the Asian region, which have created a vibrant forex market. Forex brokers are licensed by the Monetary Authority of Singapore.
Switzerland – The Swiss Financial Market Supervisory Authority (FINMA) oversees all financial market activity including foreign exchange activity.
Hong Kong – The Hong Kong Securities and Futures Commission (HKFSC) regulates the forex market. Hong Kong is also a major center for offshore forex trading in China.
Foreign brokers doing business in China have faced unexpected closures of local offices and the suspension of their business with third party payment processors. Traders with regulated Hong Kong brokers can make a claim with the Compensation Fund for trading losses
Australia – The Australian Securities and Investments Commission (ASIC) has been tightening its regulations. In 2018, forex brokers were required to keep segregated client accounts and reconcile them daily and monthly. The regulator is in the process of requiring all futures market participants meet a capital requirement of $1 million Australian dollars–the current capital requirement for forex brokers.
France – The Autorité des marchés financiers (AMF) regulates the forex market in France with additional oversight by the Autorité de contrôle prudentiel et de resolution (ACPR). In 2017, the AMF banned electronic advertising of forex and binary options but allowed CFDs. Additionally, guaranteed stop losses and negative balance protection were mandated.
The European Securities Markets Authority (ESMA) has introduced sweeping changes to forex trading. Leverage ratios have been lowered for major currency pairs to 30:1, minor forex and gold 20:1, oil 10:1 and stocks 5:1.
Forex Broker Checklist
When seeking the best regulated forex broker, forex rates should not be the key determiner. Instead, consider the regulatory regime. These risk management features are becoming best practice among regulated brokers:
- Capital requirements – Many major forex markets from the United States to Australia require that forex brokers be capitalized by around $1 million.
- Leverage – The new European leverage ratio for the major currencies is 1:30. In the United Stats, it is 1:50.
- Segregated accounts – Client funds are placed in a separate account where they cannot be used by the broker for marketing or other purposes.
- Compensation scheme – As a form of insurance, brokers are required to place a percentage of profits in an industry pool to cover potential losses.
- Guaranteed stop loss – Traders are required to set a stop-loss limit with each trade.
- Negative balance position – If an account balance turns negative, this mechanism will automatically adjust the account balance to zero.
- First-in First-out (No Hedging Rule) – This rule prohibits a trader from holding a simultaneous buy/sell position in a currency pair.
- Margin close out – The margin percentage varies but is generally increasing.
In this more prudent regulatory environment, a forex broker advertising a 200:1 or higher leverage ratio may not be regulated. Through rules, reporting, audits and enforcement actions, authorities in regulated markets are better able to protect traders from financial fraud. Traders can verify if a broker is regulated in a jurisdiction on the list of regulated forex brokers on the respective regulator’s website. Also check the regulator’s blacklist of banned brokers.
As a result of the forex trading regulatory crackdown in Europe, fewer illegal brokers are being blacklisted. European regulators also banned the use of bonuses and incentives on some FX products to get new customers to register with a forex broker. Without these enticements, fewer traders will be lured onto illegal forex broker sites.