Who regulates the currency market? – Forex regulation

Financial regulation refers to the form of supervision in which financial institutions are subjected to specific guidelines, requirements, and restrictions. In a similar manner, forex regulation encompasses the rules and laws that firms operating in the forex industry are expected to adhere to. But forex regulation goes beyond merely having rules in place as there needs to be continuous oversight and rule enforcement.

The forex market is considered the largest and most liquid market globally with a daily trade volume of over $5 billion. Due to its global reach and decentralized structure, the forex market has been more susceptible to fraud since it has been subjected to less regulation than other financial markets which is why regulation has been ramped up in recent times. This has been done to protect forex traders and investors from undisclosed financial risk and fraud so that they do not end up losing their investment capital unknowingly.

The question then becomes “who regulates the forex market?” Considering the size and scope of the forex market along with the different currencies from around the world that are eligible for trade and investment, it poses a set of unique challenges towards effective regulation. This is why instead of a single global body to regulate the forex market which is not realistic, there are governing bodies across several countries in the world to supervise forex trading around the world.

The supervisory bodies in these countries carry out forex regulation by setting guidelines that all the brokers within a particular region or country are expected to follow. Failure to comply with the guidelines is usually met with fines and penalties as determined by the regulatory bodies. Some of the guidelines for forex regulation include getting registered and licensed with the supervisory body, undergoing audits regularly, informing clients of certain changes in service, etc.

As a part of the normal forex regulation process, licensed forex brokers are subject to constant audits, reviews, and evaluations to ensure that they are adhering to the industry standards. This helps to ensure that currency trading is carried out ethically and fairly for every individual that is involved.

Apart from needing to meet minimum capital requirements, highly regulated forex brokers are nominally required to operate a different account for the funds of their clients. These funds should be separated from the operational business account of the company. Deviating from this standard practice is seen as a violation and as mentioned earlier, it will usually be met with penalties. The penalties could be monetary, loss of license, or even forced closure. It could even be elevated to criminal penalties for the principal operators of the brokerage firm since it is considered a serious offense to violate such rules. 

As a trader that holds an interest in the financial market, such a person must start with an in-depth understanding of the regulatory environment within the region they are residing in. Traders cannot ignore the fact that the regulation and enforcement of forex rules differ significantly from one region or country to another which is why a solid understanding of these rules is important. The rules will also guide traders in choosing a forex broker as their interests will be protected and they will be aware of who they are about to conduct business with.

Now, let us examine forex regulation in major countries as well as the bodies that are in charge of regulating the forex market in these countries.

Forex regulation in the United States

There are two regulatory bodies or agencies that are responsible for forex market regulation in the United States and they are the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA).

The establishment of the CFTC was done in the year 1974 to provide protection for individual investors that were involved in the futures markets before it was then extended to spot Forex transactions. The major purpose of the CFTC is to create an equal and fair trading environment for all investors and traders.

One of the ways that the CFTC has gone about achieving its ultimate goal is through the publishing of the Commitment of Traders report which is commonly referred to as the COT Report. It is released on the Friday of every week containing a list of the different trader positions by category including small speculators, large speculators, and commercial hedgers. This report is important because it gives a very transparent snapshot of net trader positions by category.

The second regulatory body is the NFA which is in charge of supervising the activities of forex brokers. The NFA is essentially in charge of registering forex brokers in the United States as well as providing them with operational licenses. It is invariably an extension of the CFTC.

Another important part of forex regulation in the United States is the Dodd Frank Act which is a crucial piece of legislation that deals with the rules and practices governing forex trading transactions in the country. It was enacted in the year 2010 and includes a reduction in the allowed leverage ratios as well as increased capital requirements for forex brokerage firms.

As a result of the strict requirements provided by the Dodd Frank Act and the two regulatory bodies, there have only been a limited number of brokerage firms that have been able to meet and maintain the forex regulation standards. Consequently, there are currently only three CFTC regulated forex brokers in the United States with the license to operate and they are Forex.com, Oanda, and TD Ameritrade.

Forex regulation in the United Kingdom

In the United Kingdom, the regulatory body in charge of forex market regulation is the Financial Conduct Authority (FCA). This agency is in charge of vetting and issuing licenses to forex brokers that are qualified. Furthermore, the agency also carries out routine checks and due diligence to ensure that all members are compliant with the statutory requirements.

The authority of the FCA is provided by the Financial Services and Markets Act 2000 which is also commonly referred to as FSMA. This act laid down stringent rules and guidelines for issuing an operational license to financial services companies that are qualified within its jurisdiction. The strict forex regulation provided by the FCA makes it one of the top-notch forex regulating agencies in the world.

Once the FCA issues a license to a company, such a company will have to adhere to strict guidelines to ensure continuous compliance. Some of the practices that must be implemented include statements for proper disclosure of risk, segregation of client funds, hiring of crucial manager roles as well as a system for preparing monthly financial statements and other reporting requirements.

Furthermore, all forex brokers that are regulated by the FCA must endeavor to be transparent and steer clear of deceptive practices that could be detrimental to the best interests of their clients. Any violations discovered by the FCA will be met with severe penalties. In addition, the FCA has limited the use of excessive leverage in forex trading and other related instruments. Together, the restrictions enforced by the FCA have ensured that there is consumer protection and traders do not lose money due to unrealistic expectations or exaggerated claims.

Forex regulation in the European Union

In the European Union, forex regulation is fragmented as most of the countries usually have their local regulatory body that is responsible for monitoring forex transactions. However, there is still a specific law that incorporates certain standards that all broker firms based in the EU need to meet. This law is known as the Markets in Financial Instruments Directive or MiFID.

The ultimate goal of the MiFID is to streamline the regulation of companies offering financial services within the countries of the European Union. After the financial crisis of the year 2008, another law was enacted called the MiFID 2 with the aim of expanding on the regulatory rules and requirements that had been put forth under the first law. Below are some of the requirements in MiFID and MiFID 2:

Maintenance of Transparency – Brokers are required to set fair and efficient market prices by adopting systems and processes for best order matching in the forex market. Also, client orders must be executed with speed and efficiency.

Client segmentation – It is mandated by the MiFID that forex brokers divide their client base into two distinct segments, Retail traders and Professional traders. This is to ensure that only the most relevant financial products and services are offered by the broker to traders based on their level of experience.

Protection of Investors – If a licensed forex broker goes bankrupt, investors have monetary protection up to a coverage limit of €20,000. However, this only applies to investors that are citizens of the European economic area (EEA). For others that might be affected who are not EEA citizens, the monetary protection is only limited to about €1000.

Forex regulation in Australia

This is provided by the Australian Securities and Investments Commission (ASIC) and it is one of the two financial regulatory bodies in Australia with the other one being the Australian Prudential Regulation Authority (APRA).

The ASIC is in charge of regulating the forex market in Australia as well as Australia’s main equity market known as the ASX. The ASIC was established in 1998 and its responsibilities have grown over the years as it also oversees the credit markets and the Chi-X exchange in Australia. Its efficiency in implementing forex regulation has been helped by the technological advancements in Australia for improving financial transactions.

For a firm to be issued an operational license by the ASIC to do business in Australia, there are high standards to be met. One is a minimum capital requirement of one million dollars while all client funds must be kept in segregated accounts within top-tier banks. The ASIC also provides education about the financial markets to traders and investors.

Forex regulation in Japan

Japan is quite a popular destination for many forex brokers due to its long history and favorable reputation for being a major financial center. The Japan Financial Services Agency (JFSA) is in charge of forex regulation in Japan. It is a government agency that was established in the year 2000 and is in charge of monitoring the activities of financial institutions, securities firms, forex brokers, and insurance companies.

The main function of the JFSA is to issue a license to forex brokers and other firms providing financial services. It also endeavors to provide investors and consumers with the protection of their financial interests. The licensed member firms are actively supervised by the JFSA to ensure that there is strict compliance with the rules and regulations that have been set forth while also imposing penalties for firms that violate any of the guidelines that have been laid out. Furthermore, the JFSA plays an active role in settling disputes that occur between clients and a member firm.

Forex regulation in Canada

Forex regulation is implemented at the national and provincial levels in Canada and two main regulatory bodies are responsible for overseeing forex market activities. They are the Canadian Securities Administration (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC). There is a high level of forex regulation in Canada due to the strict nature of requirements laid out by these two regulatory bodies which is why only a limited number of forex brokers have the license to operate in Canada.

Many of the laws that guide how forex transactions are conducted in Canada seem to be similar to that of the United States. The main regulator for forex brokers in Canada is the IIROC which also carries out routine audits of its members to ensure strict compliance. The IIROC also determines the allowable leverage that forex brokers can offer to their retail customers. The maximum leverage is currently limited to between 45:1 and 50:1 which is considerably lower than those offered by many Australian and European forex brokers.

Citizens of Canada are also protected by the Canadian Investor Protection Fund (CIPF) and the allowed maximum coverage is $1 million. However, this does not cover investors in the case of fraudulent activity by the brokerage or if the brokerage goes bankrupt.

Conclusion

From the article, it is clear that forex regulation is important due to the decentralized nature of the market as well as its high trading volume and level of liquidity. The major function of these financial regulatory agencies across different regions or jurisdictions is protecting the interests of consumers and investors.

The stringent measures in countries like the United States, Canada, and the United Kingdom mean that only a limited number of forex brokers operate in these countries. It also reduces the chances of fraudulent practices since any violation of the rules are met with adverse penalties thus ensuring brokers continuously adopt practices that are in the best interests of their clients. Traders should also take it upon themselves to be protected by only engaging in forex activities with any of the licensed and regulated forex brokers in their region.