Forex Broker
Regulations

Like any financial institution, Forex brokers have to abide by certain rules and regulations. However, because the forex market is decentralized, there are many independent regulatory bodies that control regulations at a national level. Therefore, not all Forex brokers are subject to the same regulations. Forex brokers that are based in the UK, for example, have to follow completely different rules than those based in Japan.

So the first thing to do when you’re looking into the regulatory status of your broker is to find out which authority it’s regulated under and make sure that their license is valid.

That’s the easy part. However, since most brokers won’t tell you much more about their regulator besides name and license number, it’s up to you to find out how strict/relaxed the regulator is, and what measures you need to take to protect your funds.

So to make this process easier for you, we’ve broken down the most important regulations that you must look for, and also listed the regulatory bodies that enforce this regulation.

Because of the inherent risks to capital involved in Forex trading, some regulators find it necessary to limit the trading options that brokers can provide to customers.

A common measure is to limit the leverage that brokers licensed under the regulator can provide for certain currency pairs, or in general.

Another common restriction is a ban on hedging. This means that the broker cannot allow the customer to open a sell position if they are already holding a buy position on the currency pair, as the two positions cancel each other out. In which cases, the customer pays the spread to the broker but stands no chance of profiting on the trade.

Some regulators also require brokers to hold the currencies or commodities they are offering for trade as securities, a regulation that limits the risks of another credit default swap crisis, but at the same time limits the liquidity a broker can provide.

These types of regulations are both a blessing and a curse, in the sense that they protect novice traders from taking on risks that they may not be prepared for, but at the same time they restrict more experienced traders with a larger appetite for risk and for whom the ability to hedge (with the right stops and leverages) can be a solution to market swings.

Regulators who enforce these types of restrictions include:

To protect clients' funds, some regulators require brokers to have segregated accounts for operational funds and client funds.

This is a good idea as it prevents the broker from being able to dip into client owned capital to cover operational costs and thereby ensures that your funds are ready and available whenever you wish to withdraw them.

Regulators who enforce segregated accounts include:

Certain regulators require forex brokers to deposit a predetermined amount into an investor compensation fund. This fund is set up in order to secure the client's interest in the event that the broker is unable to fulfil its contracts, i.e. to deliver the client's profits when the broker doesn't have the financial ability to do so.

If the segregated account regulation protects your deposited funds, this regulation protects your right to any profits made as a result of your investments.

However, investor compensation funds differ in how much they require forex brokers to pay into them, and how much they are willing to pay out on a client claim. Here are some examples:

Forex brokers are prime targets for money launderers, since all they need to do is deposit the money in a trading account and then withdraw it for the money to appear legitimately earned.

This is why a large majority of regulators have put in place anti-money laundering measures to prevent the abuse of forex brokers for these purposes.

How does this affect you? Mainly it means that the forex broker is required to verify your identity before allowing you to withdraw any funds back to your bank account. In most cases you will need to provide a color scan of your ID, proof of address (utility bill) and scans of your payment method.

While this might be a bit of a hassle (albeit a small one), remember that it is for a good cause and that your broker is only complying with the law.

Since Forex trading is a risky activity, some regulators consider that it is not suitable for all clients. The UK's FCA regulatory authority, for example, has very strict rules about the capital and the risk appetite of each trader, as does the Australian regulator, the ASIC.

Therefore, such authorities require that brokers must make their clients comply to conduct a suitability questionnaire. Clients that fail the questionnaire may have their trading options restricted, or be prevented from trading with the broker altogether.

In general, they have a point; Forex trading is not for everybody, however, a smaller capital and lesser risk appetite does not necessarily mean that it's not for you. So in case you want to make sure to pass your next suitability questionnaire, here's a handy cheat sheet to some of the questions you may encounter.