The new regulatory framework for forex and CFDs brokers is drawing closer, and there is one universal consensus expectation about a key aspect of the new rule that has not been discussed sufficiently. While discussions on leverage remain, brokers will likely need to provide guaranteed  Negative Balance  Negative Balance In its most basic form, a negative balance represents an account balance in which debits exceed credits. A negative balance indicates that the account holder owes money. A negative balance on a loan indicates that the loan has not been repaid in full, while a negative bank balance indicates that the account holder has overspent.In the retail brokerage space, this phenomenon occurs when a position’s losses in an account exceeds the available margin on hand from a given trader. When a trader places a trade that sharply goes against the chosen direction, an account can incur negative balance. Such exposure is traditionally very risky for brokers. While the foreign exchange market is the most liquid market in the world, unexpected economic, geopolitical or cataclysmic events can always cause a market disruption and consequently lack of liquidity.This has occurred during certain events, albeit limited, which have resulted in extraordinarily sharp movements over short timeframes such as the Swiss National Banking Crisis in early 2015.Negative balances are addressed in many jurisdictions globally and clients in the EU are protected from such risks. As a consequence, brokers are the ones which are exposed to the risks associated with covering the negative balance with a prime broker or a prime of prime. New Negative Balance Protections Look to Shield Market ParticipantsAs a countermeasure to the risk associated with negative balances on a wider scale, many brokers now have since adopted negative balance protections. These mechanisms are an automated adjustment of the account balance to zero in case it became negative after a stop out.Traders operating with a broker that offers negative balance protection often cannot lose more than deposited as this shields both the trader and broker from wider losses in times of crisis. In its most basic form, a negative balance represents an account balance in which debits exceed credits. A negative balance indicates that the account holder owes money. A negative balance on a loan indicates that the loan has not been repaid in full, while a negative bank balance indicates that the account holder has overspent.In the retail brokerage space, this phenomenon occurs when a position’s losses in an account exceeds the available margin on hand from a given trader. When a trader places a trade that sharply goes against the chosen direction, an account can incur negative balance. Such exposure is traditionally very risky for brokers. While the foreign exchange market is the most liquid market in the world, unexpected economic, geopolitical or cataclysmic events can always cause a market disruption and consequently lack of liquidity.This has occurred during certain events, albeit limited, which have resulted in extraordinarily sharp movements over short timeframes such as the Swiss National Banking Crisis in early 2015.Negative balances are addressed in many jurisdictions globally and clients in the EU are protected from such risks. As a consequence, brokers are the ones which are exposed to the risks associated with covering the negative balance with a prime broker or a prime of prime. New Negative Balance Protections Look to Shield Market ParticipantsAs a countermeasure to the risk associated with negative balances on a wider scale, many brokers now have since adopted negative balance protections. These mechanisms are an automated adjustment of the account balance to zero in case it became negative after a stop out.Traders operating with a broker that offers negative balance protection often cannot lose more than deposited as this shields both the trader and broker from wider losses in times of crisis. Read this Term protection, something that has been voluntary for firms so far.

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In a post-SNB world, as the volatility of the markets is compressed with levels of the VIX close to all-time lows, any rapid deviation from the status quo could quickly increase risks for brokers. With companies mandated to provide negative balance protection for their clients, they are being exposed to more risks.

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This is the approach that the UK FCA is taking when addressing a key aspect of negative balance protection. According to the UK financial regulator, firms are effectively taking on market risk for any prospective client losses below the value of the account.

In accordance with the FCA’s Capital Requirements Directive, brokers are required to maintain a regulatory capital level that is consistent with mitigating their market risk exposure. The UK financial regulator has sent letters to firms to inform them of the necessary provisions to meet enhanced capital requirements under the no-negative balance rules from the ESMA.

License Variations and 125K Firms

The UK regulator is outlining its concerns about a particular set of companies that are likely to be impacted more. The firms that hold a 125K license, which permits them to act as riskless principals, will need to pass on the risk to counterparts that are handling their trades.

If they are not willing to commit to no-negative balance and guaranteed stop losses, the brokerage itself will have to cover the risk. The operations of the brokerage will, therefore, be significantly impacted as it would need to tie up regulatory capital that might otherwise be used as collateral for trades with the counterpart.

Out of 97 regulated CFD firms in the UK, 23 have a 125K license. Those companies are facing a tough transition since they are forbidden from handling market risk. The FCA has reportedly asked these brokers to consider whether their current license will allow them to provide a non-negative guarantee.

Should they fail to show that it does, they are faced with a tough transition to a 730k license, which allows them to take on market risk. Given that ESMA will likely only allow a short time for firms to become compliant with the rules, it is unlikely that these firms will be able to vary their FCA permissions in time. Also, these firms will have to carry significant extra capital to cover the market risk associated with a no-negative guarantee.

At present, some FCA-regulated companies are facing the risk of failing to demonstrate adequate capitalization under the no-negative balance rules from the ESMA. There is no specific information as to whether  CySEC  CySEC The Cyprus Securities and Exchange Commission (CySEC) is a financial regulatory authority of Cyprus. CySEC is one of the key watchdog authorities for brokerages in Europe, whose financial regulations and operations comply with the European MiFID financial harmonization law.Founded in 2001, CySEC is instrumental in providing licensing and registration for forex brokers and previously binary options providers.CySEC is responsible for a variety of different functions, which includes the supervision and control of the Cyprus Stock Exchange as well as transactions executed in the Stock Exchange, its listed companies, brokers and brokerage firms.Furthermore, the regulator also supervises and monitors Licensed Investment Services Companies, Collective Investment funds, investment consultants. and mutual fund management companies.CySEC’s Role in Combatting Market AbuseOne of CySEC’s most important functions is the granting of operation licenses to investment firms, including investment consultants, brokerage firms and brokers. This includes provisions for Cyprus Investment Firms (CIF), who provide and perform investment services and activities either within Cyprus or abroad on a professional basis on certain financial instruments.Finally, CySEC oversees the imposition of administrative sanctions and disciplinary penalties to brokers, brokerage firms, and investment consultants, among others. The group has been a key force in policing the forex and binary options space, which has included several legal actions and curb market abuse. Since 2016, CySEC has sought to take a more aggressive stance against illicit behavior, while also strengthening its handling of investor complaints against entities. CySEC is currently chaired by Demetra Kalogerou, who has held the role since 2011.The CySEC is administered by a seven-member Board, which consist of the Chairman and Vice-Chairman, each of whom provide their services on a full and exclusive employment basis, and five additional non-executive members.All individuals on CySEC’s Board are appointed by the Council of Ministers following a proposal of the Minister of Finance. Their service reflects a five-year term. The Cyprus Securities and Exchange Commission (CySEC) is a financial regulatory authority of Cyprus. CySEC is one of the key watchdog authorities for brokerages in Europe, whose financial regulations and operations comply with the European MiFID financial harmonization law.Founded in 2001, CySEC is instrumental in providing licensing and registration for forex brokers and previously binary options providers.CySEC is responsible for a variety of different functions, which includes the supervision and control of the Cyprus Stock Exchange as well as transactions executed in the Stock Exchange, its listed companies, brokers and brokerage firms.Furthermore, the regulator also supervises and monitors Licensed Investment Services Companies, Collective Investment funds, investment consultants. and mutual fund management companies.CySEC’s Role in Combatting Market AbuseOne of CySEC’s most important functions is the granting of operation licenses to investment firms, including investment consultants, brokerage firms and brokers. This includes provisions for Cyprus Investment Firms (CIF), who provide and perform investment services and activities either within Cyprus or abroad on a professional basis on certain financial instruments.Finally, CySEC oversees the imposition of administrative sanctions and disciplinary penalties to brokers, brokerage firms, and investment consultants, among others. The group has been a key force in policing the forex and binary options space, which has included several legal actions and curb market abuse. Since 2016, CySEC has sought to take a more aggressive stance against illicit behavior, while also strengthening its handling of investor complaints against entities. CySEC is currently chaired by Demetra Kalogerou, who has held the role since 2011.The CySEC is administered by a seven-member Board, which consist of the Chairman and Vice-Chairman, each of whom provide their services on a full and exclusive employment basis, and five additional non-executive members.All individuals on CySEC’s Board are appointed by the Council of Ministers following a proposal of the Minister of Finance. Their service reflects a five-year term. Read this Term will take a similar approach to the one pioneered by the FCA and mandate companies to hold an extra capital buffer to cover the market risk.

Full Scope Investment Firms and Upgrading to a 730K License

The new rules might leave few choices for companies that are only holding a 125K matched principal license and are holding client money. While they do have the option to upgrade their license, the process is capital intensive and takes time.

Over the comparing months, more M&A deals involving FCA-regulated companies are expected to reshuffle the space further.

Brokers that have not been offering no-negative balance protection would be particularly vulnerable since they also need to establish the technical means for adhering to the ESMA rules.

‘Full scope’ firms that are dealing on own accounts and holding client money require €730,000 in initial capital and must follow the full capital requirements regulations.