The Basics to Online Brokers Regulation – What you Need to Know

Regulatory agencies worldwide regulate brokers and financial markets to protect investors from unlawful practices. These regulatory bodies enforce rules and regulations that brokers have to abide by. We will take a look at which these are and how does regulation work. 

One thing to note is that the regulatory body only regulates brokers in their own jurisdiction. For example, ASIC (Australian Securities and Investments Commission) is an independent supervisory authority overseeing the investment services markets and transactions of securities in Australia. 

So what does it mean that a broker is regulated?

In a nutshell, it means that the broker adheres to all the rules and regulations put in place and receives a license to operate in that jurisdiction. Regulators set rules for different aspects of trading. This includes margin requirements, balance protections, minimum capital requirements, and more. 

What do traders get with a regulated broker?

There are quite a few benefits for traders choosing a well-regulated broker.

  • Transparency – brokers have to submit regular statements and undergo audits. Choosing a regulated broker is a great way to avoid scams. 
  • Risk – regulated trading platforms have to display risk warnings before traders sign up for a trading account. This ensures you know about the average percentage of accounts that lose capital.
  • Leverage – maximum leverage that traders use is limited by the regulatory bodies. This adds an extra layer of security for traders’ capital. When trading with leverage, you are borrowing money from your broker and can lose more than your initial investment.
  • Anti-money laundering – when signing up with a regulated broker, you are required to pass ID verification and add proof of address. This helps with preventing money laundering.
  • Financial Compensation – this is in the case that your broker goes bust. For example, CySec regulated brokers have to implement the Investor Compensation Fund. This ensures you get some if not all of your funds back in case anything goes wrong.
  • Segregated funds – this means your funds are safe and segregated. In case you withdraw funds, your broker always has funds to pay you.

Brokers also benefit from regulation. Having a tier-1 regulatory oversee their operations adds a lot of trust and reputation. Another benefit is that with regulation, all brokers have to adhere to the same set of rules and don’t undermine each other.

What happens if a broker breaches regulation?

A regulatory agency can take a number of measures. One option is to strip the broker of their license, which has a massive impact on the brokers’ reputation.  In severe cases, the regulatory bodies can pursue criminal and regulatory actions. These regulators publish notices and alerts both local and international, to warn investors and potential clients.

List of regulatory bodies

Not all regulatory bodies are the same. They offer a different level of protection and have a stricter or more lenient set of rules.

US-Based Regulatory Bodies

  • FINRA – The Financial Industry Regulatory Authority regulates the exchange markets and brokerage firms. 
  • CFTC – Commodity Futures Trading Commission was established in 1974 and regulates the U.S. derivatives markets such as swaps, options, futures, and others.
  • NFA – National Futures Association is a regulatory body headquartered in Chicago. It oversees exchange-traded futures, off-exchange traded foreign currency, and over-the-counter derivatives.

International Regulatory Bodies

  • MAS – Monetary Authority of Singapore regulates a number of markets in Singapore.
  • SFC – Securities and Futures Commission is based in Hong Kong and oversees online trading in Hong Kong.
  • ASIC – Australian Securities & Investments Commission
  • FCA (was FSA)  – Financial Conduct Authority is the main regulatory body in Europe.
  • BaFin – Federal Financial Supervisory Authority is the regulator in Germany.
  • MiFID – Markets in Financial Instruments Directive is a European regulation that oversees the European Union’s financial markets. MiFID has strict rules on the regulatory disclosures for brokerage firms’ operation in the EU.
  • CySEC – Cyprus Securities and Exchange Commission is compliant with the MiFID regulation. A number of brokers have the CySEC license, as they are regarded as less stringent as other European regulators.

Forex Trading Regulation

The foreign exchange market is one of the largest markets by daily trade volume. It exceeds $5.3 trillion in daily trade volume. Countries worldwide are developing and updating regulations for the massive FX marketplace. One of the most active retail Forex markets is Japan. The FSA regulates the markets in Japan including Forex. Some of the changes include the maximum leverage allowed. 

In the US, the SEC states that all forex brokers must be registered with the (RFEDs) Retail Foreign Exchange Dealers. Normal regulations and rules are in place to protect clients as well.

Copy Trading Regulation

Some regulatory bodies are starting to regulate copy trading brokers. Copy trading is when traders automatically copy the buy and sell orders of other traders. Some regulators put rules in place that copy trading services have to register as investment managers.

Alternative Trading Systems

Alternative Trading is a basic system that isn’t regulated as a normal exchange. These systems match buy and sell orders as an ECN (electronic communication network). In most jurisdictions, these brokers have to register as broker-dealers and not exchanges. These systems only match orders electronically and don’t have regulations in place to protect the consumers. They are essential in providing liquidity.

Conclusion

Picking a regulated broker is always a good idea, as you are protected with various rules and laws brokers have to adhere to. Make sure you check brokers’ licenses, regulations, terms and conditions, before opening an account and depositing money.