Financial Regulation

Trading regulation is used to try and protect consumers from the inherently risky nature of day trading. But with as little as 5% of brokers being regulated, getting that protection isn’t always straightforward. However, as this page will show, forex, stocks, CFDs, and binary options trading regulations can benefit both traders and brokers. But firstly, let’s take a look at the meaning and protection on offer if you start trading with a regulated broker and platforms.

What is Trading Regulation?

Regulation of trading is for the most part self-explanatory. Regulatory bodies and watchdogs supervise financial markets and brokers. They enforce a range of rules and regulations to protect consumers. See further below for common rules and stipulations.

Note there is a common misconception that regulatory bodies can supervise brokers across numerous jurisdictions. However, often regulatory remit is limited to those brokers within a specific jurisdiction.

For example, CySec said the following “The Cyprus Securities and Exchange Commission (CySEC) is the independent public supervisory authority responsible for the supervision of the investment services market and transactions in transferable securities carried out in the Republic of Cyprus”.

For example, when an FX broker is regulated, they receive a license to operate within that jurisdiction, so long as they adhere to specific rules and regulations.

Unregulated brokers, on the other hand, operate without having to adhere to a set of guidelines. Arguably, therefore, they may not have the same interest in safeguarding your interests.

It’s also worth highlighting day trading regulations can span across numerous aspects of trading. For example, some brokers will have to adhere to minimum capital regulations, margin requirements, pattern day trading regulations and more.

Regulation Protection & Benefits

For Traders

So, what sort of protection and benefits do you get if you choose from a regulated broker list?

• Risk warnings – One impact of regulation is that your broker will have to display clear risk warnings before you sign up for an account. This ensures you have the full picture before you start making trades.
• Transparency – Forex brokers, for example, usually have to submit to regular audits. If the brokerage is listed as using an ECN model, it cannot manipulate trades. Not to mention, this will help keep you safe from fraudulent brokers and scams.
• Leverage limits – Another way regulation can protect consumers is through limiting maximum leverage. Trading on leverage essentially allows you to borrow capital from your broker. However, this also puts you at risk of losing more than your initial capital. So, regulatory bodies enforce maximum leverage limits to prevent individuals borrowing excessive amounts.
• Segregation – Another frequent and fair day trading regulation is that brokers must keep all operating capital separate from clients funds. This should ensure your broker honours withdrawal requests and can always afford to pay you.
• Compensation – Another advantage of regulated brokers is compensation schemes. This means if your broker goes bust, you can expect to get at least some of your funds back. For example, CySec brokers have to sign up to the Investor Compensation Fund.
• Anti-money laundering – Opting for a broker who follows regulation guidelines also brings with it a legal benefit. You are often required to provide documentation, such as Photo ID and/or proof of address. Although this may be time-consuming, this helps prevent money laundering, which is an issue that torments governments around the world.

Fundamentally, regulation helps ensure your broker offers you a quality product, fair prices and transparent processes.

For Brokers

Trading regulations don’t just benefit traders. Brokers also have a lot to gain, including:

• Reputation – The biggest advantage is that having oversight from regulatory bodies helps build a trustworthy reputation. This allows brokerages to separate themselves from fraudulent brokers and scams. As a result, they can attract more customers and increase their profits.
• Stability – The other advantage day trading regulations bring are that brokers don’t have to constantly try to undercut each other in certain areas, such as leverage limits. This allows to some extent, for a more stable and predictable future.
• Checks & balances – Regulatory oversight helps remind brokers that offering consumers high-quality products and safeguarding their interests is paramount. This means regulations can help prevent companies getting focussing solely on profit margins.

Automated Trading Regulation

Recent years have seen a substantial increase in automated, high-frequency trade. In fact, up to 70% of trades are made via these algorithmic systems. However, the high-speed and complex nature of automated systems creates issues for regulators. For example, algorithmic traders took the blame for the 2010 ‘flash crash’ that caused the Dow Jones to plummet 7% in just a few minutes.

Unsurprisingly then, significant moves have been made to introduce high-frequency, automated trading regulations. In fact, in 2015, the US CTFC unanimously approved proposals, known as ‘Regulated Automated Trading’. These rules were to bring in risk controls, transparency measures, plus a number of other safeguards.

Below is a summary of the automated regulations:

• New definitions for algorithmic traders
• Obligatory exchange controls for self-match prevention
• Registration criteria for direct connectivity to US-based FCMs and exchanges
• Pre-trade risk controls, including both cancellation systems and execution limits
• Compulsory testing environments and algorithm source code stores for automated trading systems

An increasing number of other countries and bodies are looking into the risks posed by automated systems. As a result, there could be an increase in high-frequency day trading rules and regulations in the UK, Australia, Europe, Canada and India in coming years.

Forex Regulations

Forex is one of the largest markets. In fact, daily trade volume exceeds $5.3 trillion. This is significantly more than equities and futures markets, for example. It’s no surprise then that forex trading regulations in India, the UK, US and Canada are all on the rise. In fact, countries and bodies across the world are continuously trying to effectively oversee and regulate the powerful FX marketplace.

For example, Japan is one of the world’s most active retail forex markets. There it is the Financial Services Authority (FSA) that regulates all markets, including FX. The body has been pro-active, reducing maximum leverage limits available to traders.

Likewise in the US, SEC regulations detail that those not registered with the Retail Foreign Exchange Dealers (RFEDs) will not be able to offer retail forex services. Once a Retail Foreign Exchange Dealer, brokers must adhere to similar consumer safeguards around risk management as well as other regulations.

US-Based Regulatory Bodies

• US National Futures Association – Many USA day trading regulations stem from the NFA. Their aim to protect consumers while safeguarding the integrity of the markets.
• US Commodity Futures Trading Commission – This agency is independent of the US government and oversees all FX brokers in the US. This body actively prosecutes companies who engage in fraudulent activity in the forex market.
• FINRA – The Financial Industry Regulatory Authority is a private corporation that conducts its activities as a self-regulated organisation. They are primarily concerned with regulating stocks in the US. This is the body that imposes pattern day trading regulations.
• Commodity Futures Trading Commission (CFTC) – Created in 1974, this independent agency of the US government regulates futures and options markets. As detailed above, the CFTC also plays a role in algorithmic trading regulations.

Non-US Regulatory Bodies

• FCA – Formerly the FSA, the UK’s FCA is the main regulatory body in Europe. One of the actions it takes is to impose limits on the amount of leverage brokers can offer.
• Australian Securities & Investments Commission – The commission is essentially the Australian version and combination of the US CFTC and the UK’s FCA.
• The Federal Financial Supervisory Authority – Better known as the BaFIN, it is the financial regulatory authority in Germany.
• Markets in Financial Instruments Directive – The MiFID is the closest the world has got to an overarching regulatory system. It was brought into the UK in 2007 and has been the bedrock of Europes’s financial regulatory systems since.
• CySEC – This is the financial regulatory agency in Cyprus and forms part of MiFID regulations. Interestingly, a number of overseas brokers seek licenses from CySEC. This is because requirements are thought to be less stringent than many other European regulators.
• Monetary Authority of Singapore – The MAS oversees a range of markets, including commodities trading regulations in Singapore.
• The Securities and Futures Commission – The SFC regulatory body oversees electronic trading regulations in Hong Kong.

FINRA – Financial Industry Regulatory Authority

What is FINRA?

Firstly, what does it stand for? It stands for the Financial Industry Regulatory Authority. The body is a gateway all securities firms must pass to conduct business in the US. The FINRA is a non-governmental organisation.

FINRA implements regulations to protect investors and to ensure the markets function honestly. To do that, it enforces compliance with marketing and margin rules, pattern day trader requirements and more. See below for full details of powers and regulations.

FINRA is responsible for certain duties, including membership registration, certification and arbitration. However, the overarching regulator of the securities markets, including FINRA, is the SEC.

Purpose

FINRA’s primary aim is to protect investors. To do that, it aims to make sure the US securities industry operates fairly and transparently. This objective affords the regulatory body a broad remit. In fact, they have governance over thousands of smaller tasks to achieve their aim.

These tasks can range from the investigation of new issues, such as the blockchain cryptocurrency Bitcoin, to enforcing advertising and trade reporting rules.

History

FINRA came to life on July the 26th, 2007, following the merger of the New York Stock Exchange’s regulatory committee and the National Association of Securities Dealers. This laid the foundation for a far-reaching body, responsible for regulating dealings between dealers, brokers and public investors. The idea was also to remove regulatory overlap and cut costs while retaining the same values.

The body was originally known as the Securities Industry Regulatory Authority (SIRA). However, a name change soon came about because of the similarities with the Arabic term ‘Sirah’, which are texts about the life of Muhammad.

Structure

By-laws dictate a board of governors must run FINRA. In fact, the board must be formed of:

• The CEO of FINRA
• The CEO of NYSE Regulation
• 11 Public Governors
• 10 Industry Governors

The regulatory body has over 3,400 employees with headquarters in Washington DC and New York. In addition, there are 14 other regional and district offices across numerous locations, including Chicago. Head over to the official website to find the address of your closest branch.

Essentially, those 3,400 employees provide regulatory oversight on all securities firms doing business with the public. In addition, their regulations cover those companies offering:

• Testing
• Mediation
• Arbitration
• Professional training
• Licensing of registered persons

Finally, their reach extends to market regulation by contract for the New York Stock Exchange, the NASDAQ Stock Market, Inc., the American Stock Exchange LLC, and the International Securities Exchange, LLC. This includes governance of industry utilities, such as Trade Reporting Facilities (TRF) and over-the-counter (OTC) operations.

FINRA primarily receives funding through state registration and filing/listing fees, annual member fees, plus the fines that it levies.

Note there is also an independent FINRA ombudsman office who can help you informally resolve issues with the regulatory agency. See the help desk on their official website for contact details and upcoming holidays.

Powers & Responsibilities

Regulatory Action

FINRA has a number of powers and responsibilities. Any firm dealing in equities, bonds, securities futures and options, must reach a membership agreement with the FINRA if they don’t have regulatory oversight from another SRO.

A brokers entitlement to a license can be revoked by the agency at any point. In fact, the body has almost absolute power over the renewal of licenses, expiration and disqualification. It can request audits, launch an inquiry, require an expert witness testimony and trace historical data.

Having said that, the manual dictates that FINRA usually starts with a letter of caution before resorting to severe actions, such as disqualification. To begin with, they’re likely to offer guidance on knowing your customer and safeguarding their interests.

Key Rules & Regulations

• Best execution rule – The best execution rule promises significant investor protection. It requires a broker-dealer to execute a customer’s order in a manner that offers the consumer the most benefit.
• Sustainability rule – The 2111 Suitability rule promises similar protection. It requires broker-dealers to complete private securities transactions only suitable for the particular individual following proper due diligence.
• Pay to play rule – The rule seeks to regulate actions of FINRA-listed members who partake in activities to compensate from government institutions, on the part of investment advisors.
• Taping rule – This prevents companies hiring too many employees from previously barred brokers.
• Outside business activity rule – This requires the disclosure of private securities transactions to prevent conflicts of interest.

Overall then, becoming a member firm and remaining a member firm isn’t as straightforward as many believe. In particular, if you meet the definition of an ‘institutional investor’, you will have to adhere to strict regulations.