The underlying value of the regulation of foreign exchange brokers (forex broker) is clients’ money protection. UK FCA-regulated brokers are required to keep clients’ money in Segregated accounts, which are entirely separate from business funds of the company. 2023 FCA statistics reveal that the segregated account system has managed to recover client money at the rate of 98% in the event of a broker’s insolvency (just 23% for unregulated sites). For instance, when British broker SVS Securities went under in 2020, 17,000 clients regained £108 million (94% of the lost funds) via this process, while the client fund recovery rate was only 7% following the collapse of the unregulated Seychelles platform Bforex.
Regulation significantly reduces fraud and manipulation risks. US CFTC data reports that in 2022, the violation rate by forex Brokers that are NFA-regulated was a paltry 0.9%, while for offshore-regulated sites (such as those in Saint Vincent) it was 37%. FXCM paid $7 million to the CFTC in 2017 for concealing a conflict of interest between market makers and withdrew permanently from the US marketplace. This incident prompted the NFA to amend the leverage cap rule (up to 1:50 for retail clients) in a way that the client margin call rate was reduced from 19% to 9%. Even the EU MiFID II rule obligatorily requires the reporting of the quality of order execution. For example, orders with latency greater than 100ms have to be tagged. In 2023, LMAX Exchange recorded a 65% decrease in customer complaints due to a median execution time of 0.8ms (as compared to the industry standard of 15 ms).
Regulation increases the transparency and fairness of transactions. ASIC requires forex Brokers to publish historical spread data (such as the EUR/USD non-farm payroll period standard deviation of the spread ±1.2 basis points), while black platforms are inclined to widen the spread to 5-10 basis points. Statistical data of the Swiss subsidiary of Dukascopy in 2021 prove that the likelihood of average daily slippage is only 0.2% (12% for offshore platforms), and the proportion of negative slippage is more than 60% (actual customer profit). The ESMA leverage cap (1:30 for retail accounts) reduced the margin call frequency among customers from 25% to 4% when market conditions were worst. When crude oil futures entered negative in 2020, the median loss of clients on regulated platforms was $0 (the average loss of clients on offshore platforms was $3,200).
The regulatory agency’s dispute resolution mechanism effectively safeguards rights and interests. The UK’s Financial Complaints Service (FOS) statistics reveal that in 2023, the offshore platforms had no statutory arbitration, and the forex Brokers’ complaint cycle was 35 days, while compensation rate for clients was 78% with an average of £4,200. For instance, in 2022, IG Group was ordered to compensate clients £230,000 for late execution of orders, while a complaint-handling rate of 3% regarding similar complaints on a single Vanuatu platform was attained. ASIC’s client fund compensation plan (up to an A $250,000) has a coverage rate of 99%, and in 2021, the Australian brokers’ client fund loss claim success rate stood at 95% (less than 10% in the unregulated sector).
Technical compliance eliminates systemic risks. Iso 27001 information security certification is mandated for regulated forex broker, and data leakage can only happen 0.03% (1.5% for non-regulated websites) of the time. In 2021, a Cypriot broker was breached for unencrypted user data, with 90,000 clients’ data leaked (and an annual revenue 4% fine of approximately 3.6 million euros). Also, the FCA requires stress tests for market movement in a 99% confidence level (e.g., the 7% GBP/USD one-day movement during the flash crash of the pound). As a result, in 2022, UK-based platform LCG made advance provisions to avoid client withdrawals delays caused by liquidity crises.
Historical lessons validate the requirement for regulation. During the 2008 financial crisis, the rate of loss of funds among FSA (now FCA) regulated forex broker clients was just 0.8%, while the median loss for clients of non-regulated Icelandic platforms was 89%. In the 2023 Credit Suisse case, FINMA-regulated brokers pre-froze high-risk derivative positions, keeping the net value drawdown of customer accounts below 8% (the maximum drawdown of unregulated platforms was over 40%). Regulation is not only a risk bulwark but also the pillar of industry confidence – 86% of global institutional investors only trade with top regulated licensed brokers, and the 35 trillion US dollars of assets they hold drive the compliance market to grow by 12% annually, more than seven times the growth in the offshore market at 2.3%.