The foreign exchange market (FX) is the largest, most liquid market in the world with around US$5.3 billion traded daily according to the latest Bank for International Settlements’ (BIS) triennial survey. But this is a market that is far from extensively regulated and that has no single global body to police the massive 24/7 forex market.
Spot FX, which accounts for the majority of currency trading (about
95%), is a case in point and is not regulated.
By contrast, options and
futures trades in FX are regulated as derivatives through the
Commodities Futures Trading Commission (‘CFTC’) in the U.S. and other
the relevant futures exchanges.
Banks, which are responsible for the bulk of FX trading, are heavily regulated. The U.S. Federal Reserve and the U.S.
Treasury Department pay close attention to FX markets and look for evidence of manipulation.
The biggest risk of non-regulation for retail FX traders is that of illegal activity or outright fraud. Evidencing this nearly 26,000 individuals in the U.S. lost $460 million in currency-related swindles between 2001 and 2007 . That is some financial catastrophe.
The Association for Financial Markets in Europe (AFME) published a paper last year stressing that “unintended consequences” could result in regulating the FX market too severely under MiFID II (Markets in Financial Instruments Directive II) in Europe.
The regulatory picture is nevertheless mixed. In the UK and continental Europe, regulation is limited and leverage has few limits, with levels as high as 200:1 not uncommon. In Japan, the financial regulator reduced the maximum leverage in 2011 that could be made available to retail FX traders to 25:1 from 50:1 the year before. But it shows there is a far from uniform approach globally when it comes to this market.
Probes announced in 2013 by the UK’s Financial Conduct Authority (FCA) into allegations of abuse of WM/Reuters [FX] rates and also by the Swiss Financial Market Supervisory Authority (FINMA) of several Swiss financial institutions for possible manipulation of the FX markets do indicate a coordinated international approach to tackling FX market abuses. But again it is yet to be seen if the regulators will bear down on the alleged wrong doing. The $64 million question is can the evidence actually stack up to mount any prosecutions.
While FINMA in Switzerland revealed that they were “coordinating closely with authorities” in other countries as multiple banks around the world were potentially implicated, the FCA had at the time yet to announce plans for bringing FX under the regulatory umbrella. One can only speculate as to what action they may take.
With FX trading volumes increasingly being driven by speculative transactions to profit from currency moves (about 87% of all trades in 2010), there are concerns these trades – especially by high frequency trading (HFT) firms using algorithms and rules-based trading techniques – may be contributing to heightened volatility and increasing the risk of huge losses for small retail traders.
It remains uncertain as to what shape better regulation of FX market will take and whether it can be policed effectively and on a global scale.
