Regulation provides with trust in the otherwise risky industry, it gives Forex brokers framework to guide them. Licenses mean that brokers have gone through a vetting process, their legitimacy has been confirmed. Thus, making them safer in holding your money and accessing investments and financial markets. Licenses help brokers to form and maintain meaningful partnerships with payment institutions.
Forex regulation motivates many changes in Forex and CFD trading industry with the European Securities and Markets Authority (ESMA) and now the Australian watchdog ASIC being the biggest players shaping the regulatory environment.
Regulation is important to traders because it gives them the trust of their trading associates that they have been thoroughly checked by an authority.
Brokers need regulation to look reliable to their clients and business partners. Banks and payment providers avoid doing business with Forex brokers and payment companies that do, operate with caution. Brokers reduce the risk by carefully selecting the jurisdiction they operate under and where they will be regulated. They need to consider who they look to banks and payment institutions but also their clients and deliver the services they want in a safe way with minimized risk.
FCA Regulation and Brexit
London is a major financial center and has accumulated many years of experience of regulating and maintaining stability for investors.
However, passing regulation through any jurisdiction is not easy. Cyprus Securities and Exchange Commission (CySEC) faces the same difficulties as Financial Conduct Authority (FCA). Even so, running a business in Cyprus is cheaper than in the UK and Cyprus has became a valued location for Forex business.
Brexit has thrown some uncertainty over Cyprus businesses and raised questions whether they will still be able to provide services for UK clients. Nevertheless, it’s unlikely that Brexit is going to devalue the importance of London as a financial hub.
“With the uncertainties as to what will be agreed regarding the future UK and EU relationship in respect of financial services and activities and whether any temporary measures, which were originally designed to mitigate a no-deal Brexit, will be required at the end of the Transitional Period (1 January 2021), it is difficult to predict the UK legislative and regulatory rule set post the Transitional Period.
Even without a Brexit, it has become obvious over the years that the regulatory terminology applied by the United Kingdom is quite different for a number of the services, activities and instruments when cross-referenced with the Markets in Financial instruments Directive better known as MiFID. This has resulted in confusion amongst the EU member states, especially when the financial services authorities of these member states passported their financial investment firm’s services into the United Kingdom and vice-versa. There is also no doubt, that at least for the foreseeable future, Brexit will add even more to the complexity for both financial investment firms and financial services authorities having to consider uncertainty, and potentially a whole new legislative framework not just for financial investment firms in the UK, but also UK citizens and residents wishing to become clients of EU financial investment firms and vice versa. The UK is likely to become a third country for the purposes of the EU legal framework which means that for UK firms, it will not be possible for them to rely on the existing passporting regime and will have 2 routes to be able to provide their services in the EU. That being:
- Third country equivalence regimes; or
- Third country exemptions which may be available for UK firms in certain EU countries.
On third country equivalence regimes, there is no guarantee that the EU authorities will actually make any equivalence determinations or even have the political incentive to do so in favour of the UK by the end of the Transitional Period, and even if they did, it will never be as comprehensive as the existing passporting rights which all EU firms are familiar with and use. In fact to date the European Commission has not made equivalence determinations under MiFID 2 in favour of any country so why would they do it for the UK?
On third country exemptions, this is somewhat an unharmonized area which largely depends on each member state. This means that where a financial investment firm wishes to provide its services and activities from the UK into the EU will need to be considered on a case-by-case basis, to determine if the relevant service and activity requires a license or some sort of other permission by the relevant regulatory authority of that specific member state. To some extent, there are few countries in the EU including; Germany, Netherlands, and Ireland where they have some exemptions which permit third-country firms to perform certain licensable services and activities without a local license provided the terms of the exemptions are fully fulfilled.
For the fund sector, the issues raised above will become even more complex especially since under AIFMD and UCITS marketing passports will cease to be available to UK fund mangers post Brexit.”
Cayman Islands Regulation
The Cayman Islands have an image of offshore option for brokers with relaxed business atmosphere, unburdened by regulation. They are an infamous tax haven, however, their approach to regulating capital markets is actually quite strict.
Heavy restrictions on leverage, cooperation with Introducing Brokers and PAMM managers push brokers into finding jurisdictions which allow them to provide the services that their clients want.
European Forex Regulation
ESMA’s tight regulations on offering leverage to retail brokers has made brokers seek out jurisdictions with more lenient limitations on trading conditions.
Remonda Kirketerp-Møller commented:
“As we all know, ESMA introduced temporary restriction on the marketing, distribution or sale of contracts for differences for retail clients in the EU on 1 August 2018, which consisted of: leverage limits on opening positions; a margin close out rule on a per account basis; a negative balance protection on a per account basis; preventing the use of incentives by a CFD provider; and a firm specific risk warning delivered in a standardised way. This ceased end of July 2019 since most national competent authorities have taken permanent national product intervention measures relating to contracts for differences that are at least as stringent as ESMA’s measures.
This type of intervention shows the seriousness towards greater investor protection in the EU, mainly protecting retail investors from losing more money than they put in, and restricting the use of leverage and incentives with clear risk warnings to these retail investors. This has put enormous pressure on investment firms offering CFDs as they need to meet a huge list of conditions when offering such products to retail clients. This has resulted in many financial firms ceasing to offer CFDs as part of their product offering, and many financial investment firms are trying to opt-up their clients from retail to elective professionals in order to avoid meeting the product restriction condition. How are these financial investment firms categorising these clients is another question that opens a further debate.
There is no doubt we will see more similar product restrictions coming from ESMA to continue its mission in securing investor protection. There will be even more guidelines coming from ESMA to assist the national competent authorities to guide their financial investment firms as to how to comply. Breaching these conditions by the financial investment firm will result in reversal of trades for mis-selling and hefty fines. Many countries outside the EU are adopting similar measures and some are even more stringent, which makes cross-border business even harder to achieve.
The legal and reputational risks associated with cross-border financial services have soared in recent years, largely because many countries began enforcing laws more rigorously after the financial crisis. Banks and other financial investment firms that provide services and products from their home jurisdiction into other countries must comply with the rules of the host country. To manage the risks, every financial investment firm needs a robust cross-border framework that defines market-specific requirements for products and services.
The need for RegTechs is becoming even more relevant where RegTech solutions can alleviate vast parts of this confusion and therefore aid the financial services authorities in understanding how the changes impact their jurisdiction and clients as we well as aid that financial investment firms in not only being compliant but also assist them in conquering new markets, delivering a clearer framework on any new legislative requirements and thus lead to faster onboarding. Therefore, financial institutions need not despair as seems to be the backbone reaction, but rather seek the opportunities which new developments always bring.”