Regulation in Forex Markets-Why and How?
The Foreign Exchange (FX) market is the largest, most liquid market in the world – with around US $5.3 billion traded daily. Day trading is quite common among currency traders but most investors depend on setting up trading accounts and executing their trades via Forex brokers.
There are hundreds of Forex brokers and new ones are constantly opening their doors to the public. This makes it difficult for traders to choose the best brokerage and leaves them at the mercy of the broker when it comes to honesty and transparency. Despite its huge size, regulation in the Forex market is scarce and there is no single global body to police it 24/7.
There are no accurate statistics, but the number of Forex and binary options brokers that work under a regulatory authority is minimal (5 percent is usually cited) and that leaves many firms able to take advantage of their clients and to engage in abusive behavior without any consequences.
For retail FX traders, the biggest downside to the lack of Forex regulation for most brokers is that of illegal activity or outright fraud as well as runaway losses in a market increasingly dominated by speculative activity and large institutions.
Following a spate of currency-related swindles during the period between 2001 and 2008, the CFTC created a special task force to deal with the problem and stiff Forex regulations were introduced several years later to protect retail FX traders.
Under the Commodity Exchange Act (CEA), the CFTC assumed jurisdiction over leveraged Forex transactions offered to retail clients in the United States. The Act permits only regulated entities to act as counterparties for Forex transactions with retail customers in the States and it requires that all online Forex dealers be registered and meet the strict financial standards enforced by the National Futures Association (NFA).
On the institutional level, banks, which are responsible for 95 percent of daily FX trading, are heavily regulated. The U.S. Federal Reserve and the U.S. Treasury Department are highly attentive to regulation in the Forex industry and monitor brokers carefully for evidence of manipulation.
Why is regulation in Forex so important? The objective of regulation is to ensure fair and ethical business behavior. Under current regulatory contracts, all foreign exchange brokers, investment banks and signal sellers are required to operate in strict compliance with the rules and standards laid down by the Forex regulators or their activities can be deemed unlawful. These bodies must be registered and licensed in the country where their operations are based, which ensures quality control standards are met. they are Brokerage houses are subject to periodic audits, reviews and evaluations which force them to maintain the industry standards. In addition, regulated Forex brokers must keep a sufficient amount of funds to be able to execute and complete foreign exchange contracts concluded by their clients and also to return clients’ funds intact in case of bankruptcy.
Should a regulatory agency find a broker infringing on its guidelines, it can use a wide range of enforcement powers – criminal, civil and regulatory – to protect consumers and to take action against firms or individuals that do not meet acceptable standards.
It can publish notices that are important to ensure the transparency of decision made by the authority and inform the public thereby maximizing the deterrent effect of enforcement action.
Some regulators issue alerts about financial services firms and individuals, based both overseas and in their local areas.
Of course, there can be no assurances that any action taken by a regulatory agency such as the FCA in the UK will result in a payment or return of funds or securities even where formal disciplinary actions are taken and sanctions imposed.
Many of the actions taken by regulatory agencies against the brokers covered under their authorities can also be applied to non-regulated brokers that find themselves in similar situations by police and other enforcement agencies but their mandate is limited and is less likely to be imposed leaving investors with reduced recourse in the event fraudulent behavior.
Forex regulators operate within their own jurisdictions but often work together in pursuit of duplicitous activities. In fact, in the European Union a license from one member state covers the whole continent.
Over the years regulators around the globe have tried to organize some sort of universal regulatory umbrella. MiFID (Markets in Financial Instruments Directive) was introduced in the UK in 2007 and has been the cornerstone of Europe’s financial regulatory regime since then.
The MiFID regulation is now being revised to improve the functioning of financial markets in light of the financial crisis and to strengthen investor protection. The changes are currently set to take effect from January 3rd, 2017, although discussions are taking place between the European Commission, European Parliament and the Council of the European Union about the possibility of implementation being delayed. The new legislation is known as MiFID II and includes a revised MiFID and a new Markets in Financial Instruments Regulation (MiFIR).
There are, however, powerful voices working to lobby against the wholesale Forex market coming under a wide regulatory cover. The Association for Financial Markets in Europe (‘AFME’), an industry body, has come out against the MIFID II strict regulations and has published a paper recently stressing that “unintended consequences” could result in over-regulation of the Forex industry which would prevent brokers from serving their traders comfortably.
At the moment, there is no uniform approach globally when it comes to this market. The regulatory industry continues to act on a local level with each broker applying for regulation in a chosen location and some organizations are more active than others. In Japan, one of the world's most active retail Forex market, the Financial Services Authority (FSA) regulates all markets including retail foreign exchange. The FSA is proactive in regulating retail Forex trading and has reduced the maximum leverage that can be made available to retail Forex traders several times in the last few years. In the United Kingdom where the FCA (formerly the FSA) is the main regulatory agency and in most of continental Europe, there are few limits on the amount of leverage offered.
CySEC, the financial regulatory agency of Cyprus, is part of the European MiFID regulations but it has attracted a number of overseas firms who wish to take advantage of what is seen as light regulations and an easy way to get a license without having to meet the stringent requirements that are imposed by other European financial regulators.
Presently, relative non-regulation of the institutional Forex market continues to pose ongoing risks to the retail investor which includes higher currency volatility and discrepancies in available public information.
Despite the difficulty and expense for brokers to function under an authorized regulatory body, there are many worthy brokers that choose to do so and these should be considered above all others. Traders have a wide selection of regulated brokers in their own jurisdiction or in other regions as well and they will find all the same features—and more—with regulated brokers as with non-regulated ones.