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, theMoney 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 brokeryou 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.
