In December 2016, the Financial Conduct Authority (FCA) followed in the footsteps of the Cyprus Securities Exchange Commission (CySEC) in imposing strict new regulations on the trading industry. For starters, currency traders engaged in derivatives products such as CFDs will be limited to a maximum leverage of 1:50. Additionally, a ban on trading bonuses is in place. This dramatically changes the landscape for CFD traders. The crux of the issue, according to the FCA, is that rolling spot FX products are highly complicated financial trading instruments. Most traders who engage in trading rolling spot Forex do not adequately understand the industry.
It should be pointed out that the FCA does not intend to ban FX trading in the UK – this is a multitrillion dollar per day industry globally. London is the epicenter of currency trading, and many derivatives products permitting FX trading will simply face stricter regulatory constraints. The FCA wants to make currency trading safer for traders. To achieve this objective, the FCA requires that brokerages now offer mandatory disclosure of profit/loss ratios, and risk warnings across the spectrum. To this end, the FCA will be applying pressure on brokerages to detail the historical performance of FX CFD trading accounts.
Many ideas are being floated about, but one such proposal is a maximum cap of 1:25 leverage on all inexperienced FX traders at regulated brokers. The FCA defines an inexperienced trader as one with less than 1 year of trading experience in CFDs. Other clients – experienced traders – will be limited to leverage of 1:50. This is a dramatic change in the way that currency traders will be able to trade the EUR/USD, GBP/USD, GBP/JPY, USD/JPY, USD/ZAR, GBP/EUR, and other pairs. Consider that prior to the FCA regulations, currency traders in the UK could enjoy leverage of 1:200, sometimes even more than that. With leverage, your initial capital outlay is significantly less than the value of the trade.
By limiting the available leverage, lofty profits and substantial losses can be avoided. This will make the industry less capitalized, less liquid, and less viable for unscrupulous CFD and FX trading brokerages. More importantly, the FCA is conducting an in-depth analysis of all the product offerings at brokerages, and assigning risk-related leverage caps on different products. For new traders, the new FCA regulations are particularly discouraging: no more welcome bonuses will be offered in the promotion of FX trading in CFD-related products. However, that needn’t be perceived as a bad thing since the wagering requirements for meeting the terms and conditions of bonuses are often difficult to manage.
For skilled currency traders in the UK, the FCA regulation is unlikely to have too much of an impact. While the leverage will certainly limit the potential upside/downside, skilled traders will simply have to wager more money upfront to enjoy similar benefits when trading currency pairs and derivatives products. Retail clients with a sound understanding of the financial markets will be able to enjoy a wider range of services at their preferred online brokerages. This is because FCA regulation is fomenting ingenuity, innovation, and product differentiation between providers. With bonuses taken out of the equation, Forex brokerages will now be seeking improved educational resources (webinars, seminars, economic data releases, trading courses, e-books etc.), a wider range of institutional trading accounts and options, personalized account managers, and more traditional forms of investment.
CFD-related products will inevitably be subject to stricter rules, given the many shortcomings in the industry. For the most part, it’s all about inculcating new traders with the right mindset. The attendant risks in FX trading have not been adequately addressed, resulting in some 82% losses among new traders. The strategy and competition executive director of the FCA, Christopher Woolard stressed that traders were blithely unaware of the highly complex range of products available at CFD brokerages. He drew the ire of the binary options industry by questioning whether binary bets were genuine investments. One of the most notable changes that FX brokers are putting into practice is adequate disclosure of risk warnings.
There is significant debate about the FCA’s focus at this time. Some analysts believe the FCA should be targeting the reasons why traders are losing money in the first place, and not simply limiting their losses with decreased leverage. CySEC – the Cyprus Securities Exchange Commission – regulates binary options trading, FX trading and CFD trading in Europe, and it has considered the ESMAs recommendations.
Unlike CySEC, the FCA has made the recommendations mandatory. Various other regulatory authorities in France and Poland are going to be collaborating on currency trading in general. The National Regulator approach ensures that a uniform practice will be adopted in currency trading across the UK and Europe. Since the UK remains part of the EU – the Brexit has not been initiated yet – passporting rights are still an issue. If the FCA refuses to allow high leverage, but CySEC does, passporting rights would avail these services to UK traders.