Regulation

Regulation is used to try and protect consumers from the inherently risky nature of day trading. But with as little as 5% of brokers being regulated, getting that protection isn’t always straightforward. However, as this page will show, forex, stocks, CFDs, and binary options trading regulations can benefit both traders and brokers. But firstly, let’s take a look at the meaning and protection on offer if you start trading with a regulated broker and platforms.

Regulation – What is it?

Regulation of trading is for the most part self-explanatory. Regulatory bodies and watchdogs supervise financial markets and brokers. They enforce a range of rules and regulations to protect consumers. See further below for common rules and stipulations.

Note there is a common misconception that regulatory bodies can supervise brokers across numerous jurisdictions. However, often regulatory remit is limited to those brokers within a specific jurisdiction.

For example, CySec said the following “The Cyprus Securities and Exchange Commission (CySEC) is the independent public supervisory authority responsible for the supervision of the investment services market and transactions in transferable securities carried out in the Republic of Cyprus”.

For example, when an FX broker is regulated, they receive a license to operate within that jurisdiction, so long as they adhere to specific rules and regulations.

Unregulated brokers, on the other hand, operate without having to adhere to a set of guidelines. Arguably, therefore, they may not have the same interest in safeguarding your interests.

It’s also worth highlighting day trading regulations can span across numerous aspects of trading. For example, some brokers will have to adhere to minimum capital regulations, margin requirements, pattern day trading regulations and more.

Regulation Protection & Benefits

For Traders

So, what sort of protection and benefits do you get if you choose from a regulated broker list?

  • Risk warnings – One impact of regulation is that your broker will have to display clear risk warnings before you sign up for an account. This ensures you have the full picture before you start making trades.
  • Transparency – Forex brokers, for example, usually have to submit to regular audits. If the brokerage is listed as using an ECN model, it cannot manipulate trades. Not to mention, this will help keep you safe from fraudulent brokers and scams.
  • Leverage limits – Another way regulation can protect consumers is through limiting maximum leverage. Trading on leverage essentially allows you to borrow capital from your broker. However, this also puts you at risk of losing more than your initial capital. So, regulatory bodies enforce maximum leverage limits to prevent individuals borrowing excessive amounts.
  • Segregation – Another frequent and fair day trading regulation is that brokers must keep all operating capital separate from clients funds. This should ensure your broker honours withdrawal requests and can always afford to pay you.
  • Compensation – Another advantage of regulated brokers is compensation schemes. This means if your broker goes bust, you can expect to get at least some of your funds back. For example, CySec brokers have to sign up to the Investor Compensation Fund.
  • Anti-money laundering – Opting for a broker who follows regulation guidelines also brings with it a legal benefit. You are often required to provide documentation, such as Photo ID and/or proof of address. Although this may be time-consuming, this helps prevent money laundering, which is an issue that torments governments around the world.

Fundamentally, regulation helps ensure your broker offers you a quality product, fair prices and transparent processes.

For Brokers

Trading regulations don’t just benefit traders. Brokers also have a lot to gain, including:

  • Reputation – The biggest advantage is that having oversight from regulatory bodies helps build a trustworthy reputation. This allows brokerages to separate themselves from fraudulent brokers and scams. As a result, they can attract more customers and increase their profits.
  • Stability – The other advantage day trading regulations bring are that brokers don’t have to constantly try to undercut each other in certain areas, such as leverage limits. This allows to some extent, for a more stable and predictable future.
  • Checks & balances – Regulatory oversight helps remind brokers that offering consumers high-quality products and safeguarding their interests is paramount. This means regulations can help prevent companies getting focussing solely on profit margins.

Breaching Regulations

But what happens if a broker deems trading regulations unfair and breaches them? Well, then a regulatory agency can take a number of measures. In fact, it can pursue criminal, civil and regulatory actions.

Obviously, one option is to strip the regulated broker of its status. This can do serious damage to their reputation and deter future customers. Regulatory bodies can then publish notices and issue alerts both locally and overseas to warn prospective customers.

In many ways, these regulatory agencies hold a tremendous amount of power. With an increase in scams in recent years, traders are looking more than ever for trustworthy, reliable and regulated brokers. So for example, if a broker doesn’t adhere to commodity, bitcoin or futures trading regulations, they could swiftly lose the majority of its customer base.

Are all Regulatory Bodies the Same?

It’s important to note that not all regulatory bodies offer the same levels of protection. For example, bodies outside your financial jurisdiction may not be able to promise such extensive legal recourse should there be an issue.

Bodies also enforce varying degrees of regulations. For example, all FCA brokers must segregate trader’s funds. Whereas CySec does not enforce this regulation. Furthermore, FCA licensed brokers must automate and process client withdrawals straightaway, while CySec brokers can delay withdrawals by months.

Now it isn’t necessarily that certain brokers are less interested in looking out for their customers. There may be other issues at play. For example, FCA licenses are relatively expensive. As a result, many small but still great brokers opt for CySec.

In addition, you need to check whether they are a licensed broker or a brokerage regulated by an agency. The former has legal authorisation to offer services in a country. Whereas a regulated broker has to meet the rules and guidelines laid down by the regulator.

The overarching point is that there is often a discrepancy in the reliability and extent of protection between regulatory bodies. Therefore, it is important to do your homework and not just hit the Sign Up button as soon as you see ‘regulated broker’.

Automated Trading Regulation

Recent years have seen a substantial increase in automated, high-frequency trade. In fact, up to 70% of trades are made via these algorithmic systems. However, the high-speed and complex nature of automated systems creates issues for regulators. For example, algorithmic traders took the blame for the 2010 ‘flash crash’ that caused the Dow Jones to plummet 7% in just a few minutes.

Unsurprisingly then, significant moves have been made to introduce high-frequency, automated trading regulations. In fact, in 2015, the US CTFC unanimously approved proposals, known as ‘Regulated Automated Trading’. These rules were to bring in risk controls, transparency measures, plus a number of other safeguards.

Below is a summary of the automated regulations:

  • New definitions for algorithmic traders
  • Obligatory exchange controls for self-match prevention
  • Registration criteria for direct connectivity to US-based FCMs and exchanges
  • Pre-trade risk controls, including both cancellation systems and execution limits
  • Compulsory testing environments and algorithm source code stores for automated trading systems

An increasing number of other countries and bodies are looking into the risks posed by automated systems. As a result, there could be an increase in high-frequency day trading rules and regulations in the UK, Australia, Europe, Canada and India in coming years.

Local Approaches

Day trading rules and regulations become slightly confusing in that there is no universal global approach. Instead, regulation is in force on a local level, with each brokerage applying for regulation in a specific location.

Some of the most active regulatory bodies include:

US-Based Regulatory Bodies

  • US National Futures Association – Many USA day trading regulations stem from the NFA. Their aim to protect consumers while safeguarding the integrity of the markets.
  • US Commodity Futures Trading Commission – This agency is independent of the US government and oversees all FX brokers in the US. This body actively prosecutes companies who engage in fraudulent activity in the forex market.
  • FINRA – The Financial Industry Regulatory Authority is a private corporation that conducts its activities as a self-regulated organisation. They are primarily concerned with regulating stocks in the US. This is the body that imposes pattern day trading regulations.
  • Commodity Futures Trading Commission (CFTC) – Created in 1974, this independent agency of the US government regulates futures and options markets. As detailed above, the CFTC also plays a role in algorithmic trading regulations.

Non-US Regulatory Bodies

  • FCA – Formerly the FSA, the UK’s FCA is the main regulatory body in Europe. One of the actions it takes is to impose limits on the amount of leverage brokers can offer.
  • Australian Securities & Investments Commission – The commission is essentially the Australian version and combination of the US CFTC and the UK’s FCA.
  • The Federal Financial Supervisory Authority – Better known as the BaFIN, it is the financial regulatory authority in Germany.
  • Markets in Financial Instruments Directive – The MiFID is the closest the world has got to an overarching regulatory system. It was brought into the UK in 2007 and has been the bedrock of Europes’s financial regulatory systems since.
  • CySEC – This is the financial regulatory agency in Cyprus and forms part of MiFID regulations. Interestingly, a number of overseas brokers seek licenses from CySEC. This is because requirements are thought to be less stringent than many other European regulators.
  • Monetary Authority of Singapore – The MAS oversees a range of markets, including commodities trading regulations in Singapore.
  • The Securities and Futures Commission – The SFC regulatory body oversees electronic trading regulations in Hong Kong.

Forex Regulations

Forex is one of the largest markets. In fact, daily trade volume exceeds $5.3 trillion. This is significantly more than equities and futures markets, for example. It’s no surprise then that forex trading regulations in India, the UK, US and Canada are all on the rise. In fact, countries and bodies across the world are continuously trying to effectively oversee and regulate the powerful FX marketplace.

For example, Japan is one of the world’s most active retail forex markets. There it is the Financial Services Authority (FSA) that regulates all markets, including FX. The body has been pro-active, reducing maximum leverage limits available to traders.

Likewise in the US, SEC regulations detail that those not registered with the Retail Foreign Exchange Dealers (RFEDs) will not be able to offer retail forex services. Once a Retail Foreign Exchange Dealer, brokers must adhere to similar consumer safeguards around risk management as well as other regulations.

Alternative Trading Systems

Alternative trading refers to a basic system that lacks the regulatory oversight of normal exchanges. Instead, these electronic communication networks (ECNs)  simply match buy and sell orders. Most regulations require they register as broker-dealers, instead of exchanges.

Note these alternative systems do not implement regulations to manage the behaviour of subscribers. They are only concerned with matching orders electronically. These systems actually play an essential role in providing liquidity and their global popularity is on the rise.

Copy Trading Regulations

Despite the lack of a comprehensive book, it is clear regulations are increasingly governing copy trading. This is when users copy the strategies of other traders. In fact, a number of bodies are bringing in regulations that mean copy services have to register as investment managers.

Disadvantages of Regulated Brokers

There are both pros and cons to electronic trading regulations. The first drawback of opting for a regulated broker is that you limit your access to a huge number of potential brokerages. Many of which will offer high-quality products and fantastic trading features. CherryTrade and Porter Finance, for example, are both unregulated brokers that receive glowing customer feedback.

There is also another serious disadvantage. If you are a citizen of the US, many regulated brokers will be unavailable. This is because stringent local laws and restrictions on US traders deter many legitimate but cautious brokers from opening their doors to US citizens.

Final Thoughtsday trading regulation

Overall, regulations are in place to protect consumers. So whether you’re cryptocurrency trading or speculating on stocks, choosing from a list of regulated brokers may well prove a sensible decision. So be sure to check a broker’s credentials, account regulations, policies and reputation prior to handing over any capital.

Further Reading