Israeli regulation finally cracks down on Forex

Joining the recent trends of governmental regulators such as the NFA in the US, FINMA in Switzerland and FSA in

israelcyprusJoining the recent trends of governmental regulators such as the NFA in the US, FINMA in Switzerland and FSA in the UK, Israeli Securities Authority (ISA) has finally proposed a draft for an increased oversight of the sprouting Israeli Forex industry.

Israel is one of the largest Forex hubs in the world with several dozen Forex brokers operating out of Israel, Cyprus and other offshore locations. Enjoying minimal or no regulatory environment, the brokers have operated with complete liberty so far, basically deciding on their own rules. The situation resembles the pre-NFA or pre-FINMA era in the US and Switzerland.

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The ISA has finally decided to start regulating the controversial Forex industry. Categorizing this issue as ‘urgent’, the regulators claim ‘indecencies’ occur in this market as there is a conflict of interest between Forex brokers and traders.

After the proposed legislation is confirmed by the government, the ISA will become the enforcing Forex agency and will start licensing companies and overseeing business practices, content of marketing materials and money safekeeping. The ISA will also start regulating the shareholders of the licensed Forex companies. This means that they will have to start adhering to strict requirements. For instance, a person previously convicted of committing a financial fraud will not be able to serve as a shareholder in a Forex company.

The ISA also lists several issues it intends to tackle; the following are the most important ones:

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• Sophisticated instruments (such as options) are offered to non-sophisticated clients. This can result in massive losses.

• Clients’ funds are not deposited into trust accounts and are completely owned by the brokers. I recently wrote that the NFA started dealing with this issue in the US.

• Brokers’ stability is in question as clients orders are not routed into the market. This means that brokers assume all the risk, which can backfire in some extreme scenarios.

Most significant is the fact that the new legislation is also expected to put an end to the notorious revenue sharing practice where agents (introducing brokers or affiliates) are compensated from clients’ losses. What does this mean exactly? It means that some market making brokers, who profit from clients losses, compensate their agents from these losses.

For instance, if you were referred by an agent to such a broker and lost $5,000, the agent might receive several hundred or even thousands of dollars in compensation for the referral.

This is no less than an earthquake for the prospering Israeli Forex industry. I expect a similar development in Israel to what occurred in the US following the NFA’s requirements, to happen: some brokers will stop marketing Forex to Israeli clients, some will close down and some will sell out to bigger players.

Eventually this industry should become fairer and more transparent, but this process will surely take several years, as the equivalent process in the US is far from over (in terms of transparency, at least).

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