You may have noticed that many forex brokers like to flaunt the various licenses they hold, as if they are some sort of accolade. Despite most brokers putting a lot of emphasis in their marketing messages to highlight where they are regulated and the licenses they have acquired, they do little to explain why forex regulation is essential. Because most brokers arrange their licenses on their website in a figurative trophy cabinet, the real meaning of forex regulation gets buried behind self-important marketing communications.
In developed nations, most, if not all financial services require some type of authorisation, particularly if those services are rendered to retail clients. Banks, insurers, money transfer businesses, financial advisors, and forex brokers are all subject to oversight from various authorities.
Most countries have a recognised National Competent Authority to regulate capital markets. Sometimes different agencies are responsible for regulating various sectors. For example, banking could be regulated by a country’s central bank, insurance companies could be governed by an insurance watchdog, and an investment commission can regulate insurance watchdog and investment firms.
Forex is a regulated activity in the UK, Europe, Australia, Canada, United States, Belize, South Africa, Japan, New Zealand and a few other nations. In all of these countries, there are stringent obligations that need to be satisfied; otherwise, severe penalties will be served.
Depending on the country and the sector, getting authorisation to provide financial services can be as simple as filling out a form and providing reports from time to time. For example, in New Zealand, all a broker needs to do is enlist on the Financial Services Provider Register (FSPR) and they can provide forex trading services outside of New Zealand, but not domestically. There are similar rules in jurisdictions like St. Vincent & the Grenadines (SVG) and Dominica.
There have been cases in the past where brokers misrepresent what it means to be listed on a registry. There may be some initial requirements before registration is allowed; for example, the registry may require a criminal background check be conducted. After a firm is registered, there is little oversight conveyed on the firm.
In contrast, regulated companies have to pass steep requirements before a license is issued. There are strict operational rules to be followed, firms must prepare detailed periodical reports for the regulators, and tax authorities and they must keep regulators aware of any business issues they face and how they plan to resolve them.
In this article, we shall explore what a broker needs to comply with to be licensed and authorised to provide forex and CFD trading. It’s not just a case of acquiring a license, but it’s an ongoing effort to maintain it
Regulatory authorities want to know who owns and who is running financial services companies. Having a criminal record is most certainly a big red flag and will negatively impact any application, especially if the criminal record highlights financial crimes or a history of deception.
Regulators will vet any shareholder, director or senior manager by looking at their qualifications, previous work experiences, references, financial soundness and personality.
Financial regulars want to know that any entrepreneur or investor looking to start a forex broker has sufficient capital to do so. In Europe, a broker that wants to offer the full scope of investment services is required to maintain a minimum capital of €730,000. The company should also have adequate funding to cover the cost of operations and marketing until the company reaches profitability.
The minimum capital requirement is a safety net, should the company ever run into an expected hardship, it can rely on this money to help get the company back on the right track.
The license application process itself can be very costly. Most regulators expect firms to be operationally ready when they receive the license. Even before a company is authorised to provide investment services, they may need to have an office, employees, technology and more.
Minimum capital requirements vary depending on the jurisdiction.
Brokers also have a responsibility of safeguarding clients money and must either fully segregate customer money or have clear procedures on how to protect customer money. Most regulators require that investment firms never touch customer money for operational purposes.
Know your client (KYC), anti-money laundering (AML) and countering the financing of terrorism (CFT) have been the hottest topics in finance in recent years, especially as banking and transacting have been shifting online. Forex brokers are required to uphold the same international standards as everyone else in the finance industry. Mostly, KYC, AML and CFT requirements are standard around the world.
Brokers need to monitor for any suspicious clients or fraudulent transactions and are obligated to report any suspicions to relevant authorities.
Any regulated financial services company, including forex brokers, must comply with strict reporting obligations. As an example, European regulators ensure that all EU regulated investment firms comply with MiFID II (Markets in Financial Instruments Directive).
MiFID II requires brokers to keep detailed records of their trades which include more than 50 pieces of data, including entry price and a snapshot of the market depth at the moment an order is executed. Besides records of electronic trading history, brokers have to store all communications with clients, that means email correspondence and recordings of phone conversations.
It isn’t just European forex brokers facing these strict standards. Any formally regulated broker will need to follow similar rules as determined by the authority which regulates them.
Licenced financial services companies must follow strict internal operating procedures to ensure they comply with regulations at all times and minimise any potential risks to investors. Operating manuals must govern many areas, such as how outsourcing companies are selected, how new employees are recruited, how products are marketed to clients and detailed business continuity plans in case anything goes wrong.
Brokers need to have adequate accounting procedures to make sure the company is financially sound, and customer money is safe, strict internal access controls are required in order to guarantee clients information is secure, robust record-keeping is necessary to ensure information requests form regulators can be fulfilled.
Brokers must carefully select any outsourcing or technology provider and sometimes disclose their chosen partners to their regulator.
Licensed investment firms need to demonstrate sound business continuity procedures and have remedial measures in place to manage how the company can address any unexpected events.
Most countries have a National Competent Authority to act as a watchdog, governing the companies they license and the companies that provide services to consumers in their jurisdiction. There are penalties and fines issued whenever a company fails to comply with regulations and laws.
If a broker fails to submit reports correctly or in time; if they fail to hold the minimum required amount of capital; if they mis-sell their products and services; if the company accumulates enough complaints from the public, they will be investigated by authorities.
If the regulator discovers any wrongdoing, the company will probably face a fine, a warning or sanctions. Depending on the severity and the intent, fines can range from tens of thousands of euros up to millions.
As you can probably see from the vast number of obligations listed above, brokers have a lot of responsibility when it comes to maintaining their licenses.
Legislation published by regulators can be hundreds of pages long and is often revised. Even with the best intentions, it’s still possible to break the rules without even knowing it. Because of the dangers of being found not complying with the regulation, brokers often hire expensive consultants and auditors to ensure they follow every single rule.
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