There is no single set of rules that regulates every FX broker in each EU country. Members are allowed to use the local regulator body and implement specific regulations for a fair and safe FX market. But these requirements should be relevant to the aims and standards of MiFID II. It was implemented in 2007 and is focused on maximizing customer protection in the investment sector.
With MiFID, there are other directives such as ESMA, which regulates the financial aspects of FX trading. These are the general rules for all EEA members but additionally, FX brokers are regulated by local license authorities such as Malta or Cyprus. The local regulators from the United Kingdom were also very influential for EU FX brokers but after Brexit, there are left CYSEC, BAFIN, FINMA, and other countries’ local regulators’ directives.
In this article, we will have a quick review of the ESMA and MiFID regulations. We will also outline the central points, which must be considered if you decide to become involved in the EU’s Forex market. Otherwise, violation conditions will be activated which includes quite high penalties.
How MiFID II Regulates Forex Market In The EU?
Markets in Financial Instruments Directive is the common unified standards that are required to be accepted by all EU members. It covers all kinds of investment companies in Europe. So Forex as well as CFD markets are regulated by MiFID too.
MiFID II is focused on transparency to maintain the highest level of fairness and safety. So the central regulation for FX brokers in the EU is to provide transparent reports about their business. More specifically, it covers deliverable or as well as non-deliverable forwards and swaps, including other derivatives. It does not require FX brokers to prepare pre-trade reports.
FX brokers need to have an international securities identification number ISIN. If a broker makes an investment from a market that does not have an ISIN number, an investor must be sure that the third-country regulations for FX trading meet EU requirements and standards. Otherwise, safety will be at risk.
Another included requirement is Legal Entity Identifier, same as LEI, which is responsible for the transparency of the financial transactions. It is implemented by EMIR which stands for European Market Infrastructure Regulation. These reports by FX brokers must meet the requirements of the Approved Publication Arrangement. FX markets are only obligated to public post-trade reports. Another report that is mandatory is Transaction reporting, which should be approved by ARM. All these records have to be saved for 10 years.
ESMA Regulations For FX Market
European Securities and Market Authority is an independent jurisdiction that is focused on creating a stable and high-standard financial system in the EU. So ESMA regulations cover every type of investing company including FX brokers. ESMA is a new jurisdiction that substitutes CESR, the same as the Committee of European Securities Regulators. Even though ESMA is independent, it is obligated to make reports for ECON.
How is the FX market affected by ESMA? Regulations cover needed actions for financial stability and investor safety. So primary activities include assessing risks to relevant markets, promoting convergence with supervising specific entities, and creating a united rulebook for financial markets, and operation in the EU.
For risk management, FX investors ESMA uses ESA and NCA authorities requirements and unites it with ESRB standards which stand for European Systemic Risk Board. Mostly it includes a recommendation to limit maximum allowed leverages which should be different for major and minor currency pairs.
These restrictions are active since 2018. Its aim was to minimize the frequent facts of substantial losses in the FX market. ESMA is more focused on outlines of risk management standards with frequent warnings. Leverage regulations also cover opening position leverage and initial margin protection. ESMA has strict limits for trading volumes as well as profit-generating activities.
Another aspect that is covered by ESMA is negative balance protection. Its aim is to provide safe trading for clients when exceptional circumstances happen. This covers the Forex market as well as CFDs. Companies are obligated to control and avoid high losses from clients.
If the money amount in the FX account as well as unrealized net gain is less than half of the total initial margin protection, the broker is obligated to close the clients’ account. Clients should top up their margins. Otherwise, they lose the account.
To conclude, all the mentioned requirements aim to guarantee safe Forex trading for all brokers as well as individual traders. This is why ESMA does not accept unrealistic promotions and high leverage from FX brokers. It is more focused on sending frequent warnings to maintain the stability of safety. As we mentioned, more detailed regulations are dependent on the EU member country governments but with the general risk and safety politics, ESMA as well as MiFID II directives are primary directives to approve.