The forex market is not a well regulated market.  Trading does not occur on a regulated, transparent exchange, where everyone has access to the same prices.  Unlike equities markets, where trading occurs on exchanges such as the London Stock Exchange, or the New York Stock Exchange, all foreign exchange transactions take place over the counter (also known as OTC) between willing buyers and sellers.  As a result, the price of a particular currency pair at which different brokers may offer its customers may differ significantly. 

The research team at Forex Village have analysed the regulatory regime in the US, Australia, Switzerland and the UK to help forex traders do their due diligence and research on prospective forex brokers before opening a live trading account.

Regulation of Forex Brokers in the United States

In the US, retail forex brokers are regulated by both the Commodity Futures Trading Commission (CFTC) and the National Futures Authorty (NFA). Firms are therefore required to register as a Futures Commission Merchant (FCM) with the CFTC and to register as a member of the NFA as a Forex Dealer Member (FDM).  The CFTC is given power pursuant to the Commodity Exchange Act (CEA) to require registration of firms participating in the sale of forex futures to retail customers, and to shut down any unregulated entity which is engaging in forex activities with retail customers.  In addition, the CFTC also has the authority to take action against registered FCMs for violating certain anti-fraud and anti-manipulation provisions of the CEA in connection with forex transactions with retail customers.  However, the CFTC has no power to adopt specific rules to regulate forex transactions with retail customers.  This is where the NFA comes in.

The NFA has specific rules to protect customers in the off exchange retail forex market.  FCMs/FDMs are required to meet strict financial standards, including a minimum net capital requirement based on the value of open customer positions, and are required to submit financial reports to regulators on a regular business.

In addition, the NFA's rules require forex dealer FCMs to observe high standards of commercial honour and just and equitable principles of trade in connection with the retail forex business, and to supervise their employees, agents and any affiliates that act as counterparties to retail forex transactions.

Firms that introduce customers to FCMs do not themselves need to be regulated.  The NFA's rules, however, provide that among other things,  that a forex dealer FCM must take responsibility for the activites of these introducing brokers.

The NFA keeps records of all formal proceedings against Futures Commission Merchants (FCMs).  Traders can easily go online and find out if their forex broker has had serious problems with clients or regulators.  For further information, go to the NFA's website here.

Regulatory changes

Recent changes imposed by the NFA have been aimed at keeping out of the market those firms which are weakly capitalised, and to provide more funds security for forex traders.  Thus, as of 21 December 2007, the NFA increased the capital requirement to US$5million.  In addition the NFA has boosted regulatory requirements regarding FDMs responsibilities in the areas of credit and risk management controls, recordkeeping and integrity of forex trading systems.

Some of the leading and reputable forex brokers are actually taking the initative and pressing the NFA and other authorities to take a harder line against scam forex brokers, and to increase the regulatory burden on firms involved in the retail forex business.  Clearly, when a fraudulent forex broker goes out of business, and scams innocent traders out of their funds, this has a negative affect on the whole forex industry, and therefore reputable firms have a vested interest in keeping these scam forex brokers out of the market.

Leading the charge in this respect is FXCM, which is a vocal advocate of better foreign exchange regulation and increased investor protection.  FXCM is currently pushing US Congress (through a Political Action Committee it has established) to pass legislation to extend funds segregation to the forex industry (as is the case in the UK).

Forex Regulation in Australia

Foreign Exchange (forex) trading in Australia is regulated by the Australian Securities and Investment Commission (ASIC).  ASIC requires that all companies providing foreign exchange services to retail customers must be able to show that hold an Australian Financial Services Licence, or are licenced by the Reserve Bank of Australia, or are an agent of a licensee of the Reserve Bank of Australia.

Recent changes to the regulatory environment as a result of the increase in popularity in Australia of retail foreign exchange trading has seen the regulation of foreign exchange brokers brought under the Financial Services Reform Act (FSR), administered by ASIC.  For more information, visit ASIC's website, click here.

Forex Regulation in Switzerland

Put bluntly, Swiss regulation of forex brokers and the protection of retail forex traders in Switzerland is largely non-existent.  Yes, Switzerland is one of the world's largest banking centres in the world, and there are many Swiss based forex brokers, but it is this fact that, ironically, has led many retail forex traders to believe that, by opening an account with a Swiss forex broker, that their broker will be subject to a higher level of regulation than had they opened an account with a US based forex broker.  

Currently, Swiss forex brokers have the option to operate under the regulatory regime of the government banking regulator, the Swiss Federal Banking Commission (SFBC), or to adhere to the regime of one of a number of private regulatory bodies.  There are a number of these self regulatory organisations in Switzerland (such as Organisme d'autoregulation fonde par le GSCGI, Polyreg and Association Romande des intermediares financiers).  However, these private bodies provide very little in the way of forex regulation for the retail forex trader.  Their only duty is to ensure that the appropriate anti money laundering regulations are enforced, and their regulations are not designed with investor protection in mind.

The Swiss Federal Banking Commission has recently announced that it will intervene, and bring all retail forex brokers within the banking law, which imposes a similar framework of regulation for retail forex brokers as currently operated by the National Futures Authority in the US.  However, until these new regulations are in place, many Swiss forex brokers will remain largely unregulated, and retail forex traders remain unprotected.

Forex Regulation in the United Kingdom

Regulation of forex brokers in the UK is undertaken by the Financial Services Authority (FSA).  A unique feature of the regulation of UK based forex brokers is that all forex accounts opened by a UK forex broker are required to be segregated.  This means, in practice, that in the case of bankruptcy of the forex broker, the forex trader's funds would be secured.

Links to Regulators' Websites