Survival Guide for FX Brokers

Jul 9 07:59 2009 Gen Wright Print This Article

Over the course of the past two years, regulatory oversight in the US and the global financial meltdown have changed the landscape of what it takes to be a competitive FX broker.

The FX broker market is consolidating in regulated countries like the US,Guest Posting Switzerland and Japan. If a FX broker regulated by the U.S. National Futures Association (NFA) were to fail, chances are that one morning clients might receive an e-mail from the broker's CEO informing them that their accounts will be serviced by some big firm within days. In other words, the transition to a new broker would be a bit disconcerting, but smooth. But what about if a firm is regulated elsewhere or not regulated at all?

This article takes a look at how client perceptions of brokers may be leaving some firms more vulnerable than others in light of regulatory changes.

There are two regulatory bodies with substantial experience in spot off-exchange currency (Forex) markets: the United States NFA and the United Kingdom's Financial Services Authority (FSA). The majority of the remaining regulators are either increasing their regulatory oversight in Forex – like Switzerland and Japan – or maintaining lower regulatory standards – Malta, Cyprus, Belize, and other off-shore jurisdictions.

The differences in regulatory oversight and the associated cost are dramatic. A broker outside of the NFA/FSA regulation does not have the incentive to adhere to any of the following major NFA requirements:

- Report key statistics on a daily, weekly, monthly and quarterly basis, under the threat of major fines for lateness, inaccuracy, or deception

- Keep records, transactional data and price data for years

- Have emergency contingency plans and data privacy protection plans

- Be able to prove marketing claims and have clear dispute-resolution procedures

- Screen accounts according to anti-money laundering and anti-terrorism rules

- Strictly supervise the marketing claims of authorized agents soliciting accounts

- Publish detailed risk disclosures

Since 2006, the NFA has not hidden its displeasure with (spot) Forex brokers that were not part of its on-exchange futures brokers group. It set out to fine most such regulated brokers operating in the US from 2006 through early 2008. As these brokers adhered more strictly to the newly aggressive rule enforcement, the NFA sought approval from Congress to increase the minimum capital requirement to levels that were 80 times what they were through Feb 2006.

The odds are high that the new "NFA Compliance Rule 2-43(b)" announced on April 09 will prove to be a serious regulatory overstep by the NFA. It is likely to hurt the broker industry in the United States. All brokers offering MetaTrader4, by far the most popular trading platform in the world with over 50% market share, will be particularly hard-hit. US brokers will have costly modifications to make on the client interface and broker backoffice for something that will actually deter a substantial number of traders to open accounts with them. In our opinion, UK FX brokers are best positioned to gain from this NFA controversial decisions, as long as the UK FSA does not follow the same regulatory steps.

A massive regulatory shakedown is also taking place in Switzerland, where the Swiss Federal Banking Commission had given FX brokers until Mar 2009 to register as a bank with FINMA (Swiss Financial Market Supervisory Authority) in order to continue to offer retail Forex from a Swiss headquarters. AC Markets, MIG Investments, Dukascopy, and GFX Group ( filed their banking application with FINMA by the deadline, while others sold out to existing banks or left Switzerland to less strict jurisdictions within the EU zone. The Swiss regulatory push would have greater credibility if FINMA had not dragged on the closure of fraudulent Swiss broker Crown FX for months – Crown FX was able to continue to attract clients throughout much of the shut down process while existing accounts had their accounts frozen.

Major changes also appear to be brewing in the Japanese retail FX world. Since its inception, the Japanese retail FX market has been in the hands of a few dozen Japanese brokers. There are reports that this later group routinely turned down equity stake offers in their firms from foreign brokers. Finally in late 2008, FXOnline, one of the top five Japanese brokers, sold an 87% stake to IG Markets of the UK for $207 million.

Unfortunately for domestic brokers, regulatory winds appear to have changed in Japan. In May 09, the Japanese Financial Services Authority reported that it was requesting a sharp reduction in leverage for all retail FX transactions to a maximum of 20:1 or 30:1 no later than the summer of 2009. Some believe that this change will mean higher spreads in Japan and lower liquidity during the Asian session. More likely, though, will be the gradual flow of FX accounts out of Japan and a more rapid foreign takeover of Japanese brokers.

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About Article Author

Gen Wright
Gen Wright

Javier Paz has published a full research on US broker regulations and the traders' choice of the Forexds Awards article on FX Trader Magazine. Javier is the CEO of Forex Datasource, a boutique market research firm that continues to track and attract broker evaluations from traders worldwide.

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