Global FX Market Regulation | Part 1 – A Big Dream That Requires Even Bigger Ambition

With the majority of financial services under regulatory oversight across the globe, could now be the time when the FX

The Foreign Exchange (FX) market is currently under the microscope. Regulatory agencies from Switzerland, Germany, Europe, US, UK and Australia are investigating how the FX market works in practice and whether it’s prudent to regulate it globally.

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The causes for this sudden regulatory interest have been brewing for several years, although the straw that broke the camel’s back has arguably been the recently discovered cases of widespread FX manipulation at most (if not all) large banks globally. Calls to regulate the FX market have been bandied about for a long time and plenty of potential solutions have been supplied, including creating a banking union, introducing a single-reserve currency, creating one global regulator, or putting FX trading on exchange, giving as a few examples. The one common denominator with all possibilities provided so far is that a transformation of the FX market must happen first, before global regulation is even considered.

Not Your Average Market

The FX market differs from all other asset classes in that in its current form, it is completely unregulated, operates over-the-counter, which means there is no central marketplace ,and is by far the largest by capitalization. So as regulators ponder ways to regulate this market, they first have to quantify and ring-fence its reach.

This is incredibly difficult to do because large currency transactions can take place as part of everyday life (property investment for example) and given fluctuating currency rates, people effectively speculate on currency movements without even being aware of it. With other asset classes this doesn’t apply.

Spot FX transactions are not regulated in any country, despite the assumption that the FCA, NFA, ASIC and others regulate financial services and by extension, the FX market which is part of the financial services landscape. In fact, what is actually regulated are FX derivatives such as CFDs, Futures and Options. In the case of the Financial Conduct Authority (FCA), spot FX contracts are not qualifying investments under The Financial Services and Markets Act (FSMA) and therefore, FX dealing cannot apply to the market abuse regime under and the FCA’s Code of Market Conduct guidelines. This is likely to factor into how banks defend their actions in response to FX manipulation allegations.

Chart showing worldwide financial markets regulation
International Financial Markets Regulation by Industry Segment | Source: ASIC

Muzzled but Motivated

Despite the jurisdictional quagmire, some attempts have been made to reduce market abuse and mistreatment of private retail investors. The Commodities and Futures Commission (CFTC) created a special task force in 2008 to reign in unscrupulous brokers and introduced harsh penalties in 2010 to protect retail FX traders.

One measure the CFTC was keen to implement is lowering leverage on FX trading accounts for retail clients in a bid to reduce risk taking. However, the measure made FX trading unaffordable for many traders because lower leverage meant higher margin requirements and higher initial deposits.

The knock-on effect has been for U.S traders to seek trading accounts elsewhere around the globe with lower margin requirements. Regulators seem to be creating bit-part solutions which human nature and technology find a way of avoiding before the ink is even dry on the regulatory amendment.

In the UK and Europe, regulation is limited and leverage is unrestrained with 500:1 still available depending on the broker and your trading style. Japan’s ‘Financial Services Agency’ (FSA) reduced the maximum leverage in 2011 from 50:1 to 25:1 having lowered it the year before from 100:1 to 50:1. In a similar vein, increasing numbers of Japanese traders have since looked abroad for a ‘suitable’ broker.

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Quite ironic because regulators see margin FX trading as ‘unsuitable’ for many retail investors. It seems that when it comes to leverage and risk-taking, the majority of investors/traders do not want to be restricted or ‘protected’ by regulatory guidelines and rules.

All in the Same Boat

There have been several cases of market abuse that have affected both retail and institutional investors. In the U.S, “nearly 26,000 individuals lost $460 million in currency-related swindles between 2001 and 2007,” according to a Forbes article published last month.

Investigations published in 2013 by the UK’s Financial Conduct Authority (FCA) on the abuse of WM/Reuters (FX) rates, combined with the Swiss Financial Market Supervisory Authority (FINMA) investigating several Swiss firms has cast a shadow over the FX market and added weight to calls for a complete overhaul. The German regulator, BaFin, officially confirmed cases of FX manipulation in May this year.

In December 2013, UBS agreed to pay approximately 1.4 billion Swiss francs ($1.6 billion) as part of a settlement with American, British and Swiss authorities in connection with the LIBOR inquiry. Other banks including RBS, Barclays and Lloyds have also been fined for LIBOR rate manipulation.

FINMA said it was investigating several Swiss banks but was reluctant to name them. The agency also said it was cooperating with authorities in other countries and that banks outside the country were also suspected. In a statement FINMA said it is “currently conducting investigations into several Swiss financial institutions in connection with possible manipulation of foreign exchange markets. FINMA is coordinating closely with authorities in other countries as multiple banks around the world are potentially implicated.”

In June 2014, the FCA said it was examining claims that traders at large banks manipulated some foreign exchange benchmark rates and that it might start an official investigation. It was not immediately clear if that preliminary inquiry was related to the Swiss investigation.

Questions for a Regulator

A uniformed approach to FX market standards amongst the world’s most prominent regulatory authorities does not exist and moreover, is not being sought.

Is it cynical to ask whether the 5%-10% market share occupied by the retail FX industry has any bearing on regulators’ priorities? With so many other financial market practices under scrutiny, do regulators have the resources to regulate the FX market as well? If they’re struggling to keep up with the current workload without FX, how does adding FX to their coverage help anyone aside from stretching existing resources further?

For the time being, the two biggest selling points of a global regulatory regime in the FX market is that this would curb FX manipulation amongst the largest market players and protect smaller investors using retail brokers to speculate on the FX market.

But would additional regulation be able to achieve that?


In Part 2 to be published next week. we will discuss the implications of implementing a unilateral, one-size-fits-all regulatory policy across the globe.

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