Risk Management
Perhaps many traders wonder why there is a need for regulators in financial markets. A straightforward answer is that financial regulators help mitigate risk taken.
Sometimes, the currency market moves fast. Extremely fast. As such, traders with high leverage are exposed to higher risk.
Not everyone can understand proper risk management strategies, such as using stop-loss orders or hedging positions in the derivative market. Therefore, regulators stepped in and imposed some restrictions.
For instance, in the Euro area, the maximum leverage is 1:30. It used to be much higher, such as 1:100 or more, but it all changed once regulators tightened their grip on the trading industry. It is all for customer protection because lower leverage leads to improved risk management without alternative hedging strategies.
As a rule of thumb, the more regulated a region or country is, the lower the leverage.
Forex Scams and Scandals
One of the main reasons why there is a need for a regulator in financial markets is to protect customers from forex scams and scandals. Indeed, the industry was plagued with scandals for many years.
Regulators had to step in.
By setting new industry standards, they raised the bar for brokerage houses to be able to offer their services in a specific country or region. The stricter regulation filtered the number of brokerage houses that could provide their services in that country/region, thus lowering the probability of forex scams and scandals.
Forex Regulatory Bodies
A regulatory body in the currency market has one aim and one aim only. That is, to protect investors.
It does not mean that it makes life more challenging for the broker. Instead, it lays down the rules the broker must follow and the conditions to be met to offer its services to customers in the regulator's jurisdiction.
Forex Regulations – UK, US, Asia, India, Philippines, Australia, Canada, Singapore
Each area has its own rules and regulations for the currency market. In some parts of the world, such as the Euro area, the maximum leverage is 1:30, as we already mentioned.
But conditions differ. Some countries are less strict, for example.
In the United Kingdom, the FCA sets the standards for the industry. It is one of the most respected financial authorities in the world. Complying with the FCA rules is often a significant step for a broker to establish trust with investors.
The Securities and Exchange Commission in the United States sets the rules to follow. Complying with the SEC comes at high costs for brokers, but the reward is having access to customers in the largest economy in the world, with high income and strong risk appetite.
Asia is a large part of the FX market. In particular, Japanese investors are well accustomed to the currency market and willing to take risks. Some other traders in different parts of the world would not do so. The Financial Services Agency of Japan, or JFSA, regulates currency trading. Each Asian country has its regulator, such as the BSP (Bangko Sentral ng Pilipinas).
Here are other important regulators:
- ASIC (Australian Securities and Investments Commission)
- IIROC (Industry Regulatory Organization of Canada)
- MAS (Monetary Authority of Singapore)
The Need for Regulation
Some traders/investors, as well as brokers, see regulation as a burden. Unnecessary.
But the truth is that the forex regulations establish some limits to an industry known for its high volatility and an increasing number of speculators. With its rules and norms, regulation establishes an environment where only the best of the best survive – both from the investors' world and the brokerage houses' world.
Investor Protection
Investor protection is paramount in financial markets. Forex is not an exception.
It is only relatively recently that regulators tightened their grip on the forex market. All to protect the investor.
For those still struggling to understand why regulation is necessary for investor protection, we should not look back more than 2015. In January of that year, the Swiss National Bank (SNB) dropped the 1.20 floor it held for EUR/CHF. The decision took markets by surprise.
As a result, the EUR/CHF and other CHF pairs moved sharply. The next available quote for the EUR/CHF was below 0.90 in the following minutes. Investors took losses and also did brokers. The regulation was loose, and investors did not benefit from negative balance protection as it is now.
Since then, investors' protection increased thanks to tighter regulation. To an extent, the broker's protection increased, too.
Ensuring Transparency
Transparency is key to the FX industry. A regulated broker has all its cards on the table. Namely:
- Jurisdictions where it is regulated
- License number
- Where the investor could check
- All information publicly displayed
All of the above lead to transparency, which leads to trust and confidence. Those are critical for both investors and brokers.
Maintaining Market Integrity
Regulators also serve the role of maintaining market integrity. Promoting market integrity is a way to attract new investors; thus, regulators have their specific role in the market.
Investors need to be assured that the brokers act in their best interests and that there is nothing dubious about dealing with a regulated broker.
Promoting Financial Stability
Regulation brings financial stability. To continue with the same example mentioned before, after the SNB dropped its 1.20 EUR/CHF peg in 2015, many brokers went bust, even in developed countries.
However, regulation helped protect customers' funds. Despite brokers going bust, customers recovered their losses to the extent the regulator imposed conditions on the broker. This was not the case in other parts of the world with unregulated brokers.
The Crucial Role of Regulators
Regulators are crucial in promoting and maintaining market stability and financial integrity. One should not trade with an unregulated broker because, in doing so, the risks increase considerably.
Licensing and Supervision
Every broker that wants to operate in a country or region needs to be supervised by the local financial authority. Supervision implies compliance with local rules and, in the end, a license. A license to operate is not easy to obtain. Moreover, it is not easy to maintain.
Brokers need to constantly submit compliance forms with what the regulator asks to keep their license. This way, investors with a broker with an active license are assured that the broker is safe to trade with.
Standardization
Another vital point regulation brings is standardization. Every broker must follow the same rules to be licensed to operate in a specific jurisdiction.
As such, investors' confidence increases, and brokers compete to offer the best conditions possible. In return, the investors benefit from it.
Market Surveillance
Regulators keep an eye on the market. That is, not on the actual financial market but on the participants.
They constantly revise complaints, for example. Also, they have bodies actively involved in monitoring the risks associated with certain brokers. More precisely, regulators observe markets and stand ready to act should they see some participants cross certain lines.
Consumer Education
Another important point about the regulator's role is customer education. No one should trade with an unregulated broker because the risks of losing the invested capital are much higher than with a regulated one.
Knowing that a broker is regulated increases trust in financial markets. Moreover, it increases the investors' risk appetite, knowing that the broker is a partner in the investment journey.
Fraud Deterrence
Regulation prevents fraud. There are so many examples of fraud in the industry and all of them relate to unregulated brokers.
Nowadays, such a thing is incomprehensible if trading with a regulated broker. Thus, regulation comes with protection and fraud deterrence.
Expert Tip – Forex Regulations
Unregulated brokers are a no-go. Under no circumstances should one choose such a broker.
Sure enough, unregulated brokers always offer attractive conditions. However, the risk of dealing with such brokers in the long run far outpaces the rewards.
Therefore, look for a broker qualified for forex trading regulations criteria when trading the forex market. Currency trading is difficult enough without worrying about whether the broker is on your side.
FAQ
The main risk is losing all the invested capital, as the broker can quickly go bust.
There is a financial authority in each country/region. Regulation in developed countries is much stricter than in developing or emerging ones.
Yes. A regulated broker must respond to any dispute and provide viable solutions. The regulator will rule which party is correct, and the parties comply.
For a trader, a regulated broker brings trust to the investing process. This means the broker is a partner in investing, only charging a fee for routing orders to the market.
Regulation brings transparency and trust to an industry that has suffered from such things.