Forex exchanges across the globe run continuously through OTC (over-the-counter) markets. Forex markets have few boundaries, and this allows for seamless access. For instance, a Japanese trader can trade in euros and dollars (EURUSD) via a broker based in Canada.
This speculative international trading is growing day by day. Unfortunately, some banks and brokers who are the intermediaries decide to engage in scams, ridiculous charges, hidden fees, financial misdeeds, high leverage levels, among other bad financial practices.
This is where authorities come in to ensure that negligence in trading is avoided. For instance, internet and mobile-based forex trading are very smooth trading platforms, but they present a risk to traders whereby these sites can shut down suddenly and flee with investor cash.
Regulations are geared towards protecting individual investors and ensuring fair play to protect the interests of clients. The top concerns traders should have when picking forex brokers are the approval status of the broker and the broker’s governing authority. Let’s look at how authorities regulate brokers and how investors can verify a broker’s status.
How Do Authorities Regulate Forex Brokerage Accounts?
In the US, the NFA (National Futures Association) is the supreme and sole provider of efficient and cutting-edge regulatory programs that maintain the reliability of derivatives markets such as forex. The responsibilities of the NFA include:
- To give eligible brokers the required licenses so that they can conduct their trading business. Due diligence has to be done before the license is issued.
- To ensure brokers adhere to the necessary capital requirements.
- To combat racketeering.
- To ensure brokers keep records of all transactions and related business activities.
What Are the Stipulations of US Brokerage Guidelines?
The requirements in brokerage regulations are geared towards protecting clients defined as having assets less than $10 million. These requirements include:
- No hedging while trading forex currency pairs.
- For long forex options, the whole option premium should be kept as security.
- The theoretical transaction value and options premium should be kept as a security deposit for short forex options.
- The existing leverage is limited to 50:1 or 2% of the theoretical value of a forex transaction. This requirement is for major currencies, so that beginning investors don’t take unprecedented risks. Some of the major currencies include the American Dollar, British Pound, Euro, Japanese Yen, Canadian Dollar, Danish Krone, among others.
- The existing leverage is limited to 20:1 or 5% of the theoretical value of a forex transaction. This requirement is for minor currencies.
- FIFO (first-in-first-out): this rule prevents brokers from holding concurrent positions in the same asset. This means that any open trade position (buy/sell) in a specific currency pair will be squared off for the reverse position (sell/buy) in the same currency pair.
Note that the money that forex brokers owe their clients should only be held in one or more approved financial institutions.
How Can Investors Verify a Broker’s Status?
The NFA has an online authentication system known as BASIC (Background Affiliation Status Information Center). Using this system, investors can verify the status of brokerage firms in the US using their NFA ID, company name, or staff name.
When using BASIC, ensure you enter the correct ID or name in the correct format because some brokerage firms go by various names. For instance, the name on the webpage may be different from the name used in legal or corporate documents.
How Do Brokerage Regulations Vary?
Many brokerage websites claim to have high leverage and low brokerage fees. This means that investors will have more trading exposure even with minimum capital. However, most of these sites are hosted and operated outside the US, and they may not even be approved by the relevant authorities where their base of operations is located.
As a result, investors should proceed with caution when picking brokerage firms by verifying the proprietorship, status, and location. In addition, regulations on available leverage, capital requirements, and investor protection will vary from country to country.
To sum it all up, in the US, financial regulations governing forex brokers are multifaceted, and they regularly change as markets develop. These regulations are put in place to protect investors from shady broker deals that could eat up all their investments.