The Foreign Exchange Professionals Association (FXPA) has released a white paper urging policymakers to address regulatory disparities between regulated and unregulated foreign exchange (FX) derivatives trading venues. The industry group warns that the current landscape may pose risks to market integrity and customer protection.

FXPA Calls for Regulatory Parity in FX Derivatives Trading Venues

In its report, the FXPA emphasizes the growing presence of unregulated FX derivatives trading platforms competing directly with their regulated counterparts. These unregulated venues often operate with minimal oversight, potentially offering benefits such as higher leverage and lower fees, but at the cost of reduced customer safeguards.

“The longer regulatory gaps between regulated FX derivatives trading venues and unregulated FX derivatives trading venues can be exploited, the more other FX trading venues will seek to replicate their success,” the FXPA stated in its white paper.

The association highlights several key differences between regulated and unregulated platforms. Regulated venues face higher operational costs due to compliance requirements, including market surveillance, reporting, and investor protection measures. They also adhere to strict rules on transparency, conflicts of interest, and impartial access.

“The presence of unregulated FX derivatives trading venues also introduces the possibility of regulatory arbitrage for FX markets. These dynamics raise concerns about fairness and market integrity around the operation of unregulated FX derivatives trading venues,” the paper further states.

FXPA suggests that unregulated venues may benefit from cost savings associated with non-compliance, allowing them to offer more attractive terms to customers. This dynamic could potentially impact market liquidity and price discovery.

The Association calls on global regulatory bodies to evaluate the effects of unregulated FX derivatives trading venues providing services that are typically subject to oversight. The group recommends considering these platforms as comparable to their regulated counterparts, regardless of how they present themselves to the market.

“Policymakers should take into account how the operational structures of unregulated FX derivatives trading venues impact systemic risk management, market development, and global competitiveness,” the white paper advises.

The association also suggests that regulators could support regulated entities by reducing regulatory cost burdens through normalizing standards across jurisdictions and allowing greater equivalence for entities operating in multiple markets.

Surge in Forex OTC Derivatives

The OTC derivatives market saw significant expansion in 2023, with total outstanding contracts reaching $667 trillion, an 8% increase from the previous year. Interest rate derivatives, which grew to $530 trillion, and foreign exchange derivatives, which rose to $118 trillion, were the main drivers of this growth.

The Bank for International Settlements (BIS) reported a distinctive pattern in market activity throughout the year. Notional amounts surged by 15% in the first six months, followed by a 6% contraction in the latter half. This fluctuation aligns with a recurring seasonal trend observed in recent years.

Despite the overall growth in notional value, the gross market value of OTC derivatives fell by 13% in 2023. This decline was primarily due to changes in interest rate derivatives, which peaked in late 2022 amid rapid interest rate hikes. As rate increases moderated in 2023, the market value of these derivatives subsequently decreased.