To many regulators around the world, the words “foreign exchange broker” have become a dirty phrase. Indeed, over the last five years there has been a global trend to regulate the industry into oblivion. This started in 2010 with the National Futures Association (NFA) reducing an industry with over 52 Retail Foreign Exchange Dealers (“RFED”) and a further 181 introducing brokers to an industry with now only 6 RFEDs.
Moreover, recently Belgium has banned Margin FX altogether. France has proceeded to ban all Margin FX advertising – a move akin to cigarette advertising prohibitions in the early 1990’s in Australia. CySEC Chairwoman Demtra Kalogerou made headlines when she chastised the industry for what she regards as deviations from best practice within financial services.
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Foreign exchange regulations are now even within the ambit of the divine’s auspice – with Pope Francis predicted to warn of the risks of Binary Options. In the UK, Leverage limits are to be imposed on FCA regulated brokers. Closer to home, the Australian Securities and Investments Commission (ASIC) has issued s 912C Notices under the Corporations Act 2001 (Cth) as part of an industry wide surveillance.
The foreign exchange industry, like most industries has a diverse mix of participants, most of whom provide their services in a professional, honest and fair manner. Regrettably, there are a small number of participants who act nefariously and are a blight on our industry. There is little doubt that if our industry is to operate- we must stamp out such behavior.
Social license
It seems abundantly clear that the industry’s future is contingent on its ability to operate with a social license. Where social license is taken to mean the ongoing acceptance or approval from the local community and other stakeholders including global financial regulators.
In their seminal academic piece, Thomson and Boutilier have developed a cumulative pyramid model of a social license, which identifies three central components: legitimacy, credibility and trust.
According to this model, an organization or industry must first develop legitimacy with stakeholders, which will be followed by credibility, and finally by trust. They identified the quality of a social license held by a company as being inversely related to the level of socio-political risk it faces.
Hence, an organization with little legitimacy in the community has a high risk of having its social license withdrawn. Conversely, an organization that is highly trusted by its relevant stakeholders has a strong and entrenched social license to operate.
It faces a low risk of losing access to its essential resources such as a financial services license. One challenge which global regulators face is information asymmetry and resource scarcity.
This was highlighted in Demtra Kalogerou’s recent speech, where she highlighted the difficulty of a regulator to provide effective supervision to such a large industry, which accounts for 80 percent of the entire EU retail FX market.
In the author’s view there are four key areas, for which a financial regulator must regulate to ensure transparency and confidence in financial markets. These are:
- Solvency
- Pricing
- AML
- Misleading and deceptive conduct
Put simply, in a client’s perceptive these are:
- Am I going to get my money back?
- Am I getting a fair market price?
- Does the firm have significant procedures in place to stop organized crime terrorism financing which is detrimental to society as a whole?
- Is the broker lying to me to induce me to invest?
Often these issues are not identified by a regulator until it is too late. In the cases of IronFX and MF Global, regulators were not able to step-in before client losses had already occurred.
Fortunately, with technological advances, regulators will now be able to identify in real-time the solvency of the firm; and will be able to confirm and verify the prices provided to clients are the fair market price. Regulators will, in tomorrow’s regulatory landscape, have access to foreign exchange brokers’ KYC process and with the ability of enforcing strict compliance through software.
While it is impossible to stop misleading and deceptive conduct from unscrupulous individuals, the regulators of tomorrow will be able to see all advertisements published by a broker, the location of the publication and the person who approved publication.
With technology, the regulator of the future will be able to, at a faction of the previous cost, protect client funds IN REAL TIME and ensure confidence and transparency in the financial market. Technology will provide retail foreign exchange the social license, which it requires to continue to operate.
