Forex Market Regulation: Why and How?

The forex market (FX) is the largest and most liquid market in the world, with about $ 5300 million traded daily. Day trading is quite common among forex traders, but most investors depend on the creation of trading accounts and the execution of their trades through the Forex brokers.

There are hundreds of Forex brokers and new brokers constantly open their doors to the public. This makes it difficult to choose the best broker and leaves traders at the mercy of the broker when it comes to honesty and transparency. Despite its enormous size, regulation in the Forex market is scarce and there is not a single global body to monitor it 24/7.

There are no accurate statistics, but the number of forex brokers and binary options that work under a regulatory authority is minimal (an estimated 5 percent) and that gives many companies the ability to take advantage of their clients and engage in abusive practices without consequences.

The Risk of Non-Regulation

For forex retail traders, the biggest disadvantage of the lack of regulation of the forex market of most brokers is the illegal activity or absolute fraud, as well as losses in a market increasingly dominated by speculative activity and the great institutions.

After a series of scams related to the forex market during the period between 2001 and 2008, the CFTC created a special working group to deal with the problem and introduced tight forex regulations several years later to protect retail traders currency.

Under the Commodity Trade Act (CEA), the CFTC assumed jurisdiction over leveraged Forex transactions offered to retail customers in the United States. This Act only allows regulated entities to act as counterparties to forex transactions with US retail clients and requires all forex brokers in the United States online to be registered and comply with the strict financial rules applied by the National Futures Association (NFA).

At the institutional level, banks, which are responsible for 95 percent of the daily currency trade, are heavily regulated. The US Federal Reserve and the US Treasury Department are very attentive to the regulation of the Forex industry and carefully monitor brokers for evidence of manipulation.

Forex Regulation: Why?

Why is Forex regulation so important? The aim of regulation is to ensure fair and ethical business behavior. Under current regulatory contracts, all forex brokers, investment banks and signal traders are required to operate in strict compliance with the rules and regulations set by forex regulators or their activities may be considered illegal. These agencies must be registered and authorized in the country where they base their operations, which ensures that the quality control standards are met. Brokerage houses are subject to audits, reviews and periodic assessments that force them to maintain industry standards. In addition, regulated Forex brokers must maintain a sufficient amount of funds to be able to execute and complete the currency contracts made by their clients and also to return the funds of the clients in case of bankruptcy.

If a regulator finds a broker in violation of its guidelines, it can use a wide range of powers - criminal, civil and regulatory - to protect consumers and take action against companies or individuals that do not meet acceptable standards.

It can publish notices that are important to ensure the transparency of the decision taken by the authority and inform the public, thus maximizing the deterrent effect of enforcement action.

Some regulators issue alerts on financial services companies and individuals both abroad and in their local areas.

Of course, there can be no assurance that any action taken by a regulatory agency, such as the FCA in the United Kingdom, will result in payment or refund of funds or securities, even when formal disciplinary action is taken and sanctions are imposed.

Many of the measures taken by regulatory agencies against brokers covered by their authorities may also apply to unregulated brokers who find themselves in similar situations by the police and other coercive agencies, but their mandate is limited and less likely that is imposed, thus leaving investors with few resources in case of fraudulent practices.

Forex regulators operate within their own jurisdictions, but often work together to look for suspicious activity. In fact, in the European Union, a single Member State license covers the entire continent.

Over the years, regulators around the world have tried to organize some sort of universal regulatory body. The MiFID (Financial Instruments Markets) Directive was introduced in the United Kingdom in 2007 and has been the cornerstone of Europe's financial regulation regime ever since.

The MiFID Regulation is being revised to improve the functioning of financial markets in the wake of the financial crisis and to strengthen investor protection. The changes came into force on 3 January 2017, although discussions are being held between the European Commission, the European Parliament and the Council of the European Union on the possibility of delaying implementation. The new legislation is known as MiFID II and includes a revised MiFID and a new Financial Instruments Market Regulation (MiFIR).

There are, however, powerful voices working to exert pressure for the wholesale forex market to have a broad regulatory base. The European Financial Markets Association (AFME), a body in the sector, has opposed the strict rules of MIFID II and has recently published a document stressing that "unforeseen consequences" could lead to excessive regulation of the Forex sector that would prevent brokers from serving their traders comfortably.