Not all Forex brokers are regulated, and amongst regulated brokers, there exist different levels of regulations.
Regulations protect traders from evil activities such as unfair price fills and theft of client money. However, a thriving group of unregulated Forex brokers often offer more flexibility than their regulated counterparts, such as higher leverage and access to a broader choice of markets.
Let’s explore the world of unregulated Forex brokers to examine their risks versus potential rewards.
Remember, Forex is an over-the-counter market, meaning transactions do not pass through a central exchange. Other major markets have exchanges; for example, the US stock market has the New York Stock Exchange and Nasdaq, and US futures have the Chicago Mercantile Exchange (CME). Most major exchanges require brokers accessing them to abide by regulations.
The lack of a central exchange means Forex brokers transact directly with other brokers and liquidity providers. However, suppose a broker sets up in a country that does not regulate Forex. In that case, they won’t need to abide by regulations because there’s no central exchange.
Before diving into the world of unregulated Forex brokers, let’s look at the various types of regulators, as there are vast differences in how they operate.
Deciding whether to use an unregulated Forex broker also means deciding what type of regulation I use as a comparison. Let’s explore the different categories of regulators.
Top-tier regulators command the highest standards from brokers operating in their jurisdiction. For example, they require:
- Client money protection: Brokers must keep client funds in separate accounts. This is known as “segregated client accounts.” This helps to protect client money if a broker becomes insolvent. (In some jurisdictions, investor funds must also be insured to guarantee reimbursement if the broker becomes insolvent.)
- Risk management: Forex brokers must have robust procedures to ensure their clients are not exposed to excessive risk. This includes setting appropriate leverage limits and margin requirements.
- Disclosure requirements: Forex brokers must provide clients with clear and accurate fee information.
- Complaints handling: Brokers must have a formal complaint-handling process to handle client complaints promptly and fairly.
- Anti-money laundering (AML) and know-your-customer (KYC) requirements: Forex brokers must comply with regulations to prevent money laundering and terrorist financing.
- Training and competence: Forex brokers must ensure their employees are appropriately trained and competent to perform their roles.
- Fair trading practices: Brokers must execute trades at fair prices that reflect market conditions.
Top tier regulators are in the countries with the strongest financial markets. These include:
Mid-tier regulators are in less strong financial markets with less stringent requirements than the top-tier list. Mid-tier regulators include:
- Cyprus: Cyprus Securities and Exchange Commission (CySEC). As an EU member state, CySEC’s financial regulations and operations comply with the European MiFID financial harmonization law. A significant number of overseas retail forex brokers have obtained registration from CySEC.
- Malta: Malta Financial Services Department (MFSA)
- Latvia: Financial and Capital Markets Commission of Latvia (FCMC).
Bottom-tier regulators have a combination of the lowest oversight, the least history as regulators and the lowest enforcement levels. Many of these regulators belong to smaller or developing nations. Examples include:
Most unregulated Forex Brokers do not advertise that they are unregulated because it’s not considered a benefit to clients! Almost always, the only way to know if a broker is unregulated is to research the broker.
Step 2: Verify the broker’s information on the regulator’s website.
Most regulators have a page on their website to verify a broker’s regulatory status. Enter the broker’s registration number or name—the page will confirm whether the broker is regulated in their jurisdiction.
If you are still looking for any regulatory information on the broker’s website, contact the broker and ask about their regulatory status. Preferably, get the answer in writing. Verify their position on the regulator’s website if they claim to have regulation.
Not having regulation is not necessarily bad, and each side has pros and cons.
- Higher leverage.
Many regulators restricted leverage as part of their risk management mandate. For example, US regulators restrict leverage to 50:1, and the UK’s FCA and Australia’s ASIC limit leverage to 30:1 on major Forex pairs. Unregulated Forex brokers do not have to abide by these restrictions. As a result, many offer much higher leverage: 100:1, 500:1, even 2000:1. This is great for accounts of any size, especially smaller ones. Probably the most significant reason traders choose unregulated brokers is for higher leverage.
- Lower deposit requirements.
Unregulated brokers often require relatively low deposits. This is great if you are new to Forex and want to test the waters with a smaller account size. One of the first rules of trading is to risk only capital you can afford to lose.
- Lower spreads & trading costs.
Getting regulated can be expensive for a broker. Unregulated Forex brokers can often afford lower spreads and commissions because they do not have the additional cost of regulation.
- Access to markets.
Unregulated Forex brokers can be the easiest way to access markets for traders in certain countries because some regulators restrict specific markets. For example, US regulators do not permit CFDs, and other regulators have banned Forex trading or binary options.
- Segregation of client funds.
Unregulated Forex brokers are not obliged to hold client money in separate accounts from their company operations. In contrast, almost all regulators require brokers to segregate client funds and never use them for their company operations—this is one of the most critical protections regulations offer and a key reason many traders will only use regulated brokers. Unregulated brokers may claim that they hold client money separately. Still, there is no way to check without the oversight of a regulator.
- Difficulty withdrawing funds.
Nothing stops unregulated brokers from delaying or blocking the withdrawal of funds, for example, if the broker is facing financial difficulties or simply stealing client money. These have been real issues—some unregulated brokers have not returned client deposits, and clients have almost no legal recourse.
- Unfair trading conditions.
Because Forex is an OTC market without a centralized exchange, traders are reliant on brokers executing trades at fair prices. Some regulators require that brokers execute at prices that reflect market conditions. Unregulated brokers do not have that obligation and may execute poorly to the disadvantage of their clients.
- Lower solvency standards.
Regulators often require that brokers under their jurisdiction have minimum levels of financial stability, for example, through cash reserves. Unregulated brokers are held to different standards, increasing their chances of financial instability. This also increases the chances of the broker taking client funds when facing financial difficulties since they are not obliged to hold them in separate accounts.
- Other fraudulent activities.
Getting regulated means the regulatory body knows the people behind the brokerage’s operations, and it’s harder for those individuals to commit fraudulent acts without legal consequences.
Just because a broker has chosen not to pursue regulation does not automatically make them a scam. Let’s first look at how a broker may scam clients:
- Is the broker refusing withdrawals? Or only allowing the withdrawal of original balances and not profits?
- Is the broker executing trades that do not reflect the prices on the chart?
An unregulated Forex broker must show a repeated pattern of these behaviours to be considered a scam.
Here are two ways to check if a broker is a scam:
- Search the broker’s name online and check reviews.
Search the broker’s name online to look for any commentary or reviews. Regulators often make public announcements to avoid brokers who have scammed residents in their jurisdictions. Also, reviews from actual clients help determine whether to trust a broker.
- Start with a test deposit and withdrawal.
Deposit a small amount and place some small trades. Did the trades execute at prices reflected on the chart? Are you able to withdraw funds quickly and easily?
- The cost of regulation.
Regulatory organizations often charge brokers annual fees to keep their regulatory status. For example, the US’s National Futures Association (NFA) charges for retail Forex brokers start at $125,000 annually. There is also the cost of abiding by the regulators’ requirements, such as audits or holding cash reserves.
- More flexibility outside of regulation.
Some regulators restrict instruments such as CFDs or binary options, or leverage. Unregulated Forex brokers can sidestep these restrictions and offer more options to their clients.
Some brokers are in regions that do not have a regulatory framework.
- Safety of funds.
This is the most significant risk that unregulated brokers possess because they are not required to hold client funds in separate bank accounts from their operations. Unregulated brokers could not return client money anytime, even if it is outright fraud, and customers would have almost no legal recourse.
- Unfair trade fills.
This is a more deceptive but equally damaging way of stealing from clients. Without regulatory oversight, unregulated brokers could fill at whatever prices they deem fit regardless of market prices – blaming it on slippage – or not fill or recognize profitable trades. Unfortunately, this has been common amongst a small segment of unregulated brokers.
- Is the broker running a trading operation? This sounds like a silly question to ask, but there are instances of brokers not trading for clients. When a client opens and closes a trade, the account balance reflects a profit or loss. However, the broker has not placed a trade for the clients. The clients are trading against each other—the losses of some fund the profits of others. However, if a trader makes a much larger-than-expected profit on a trade, the broker does not recognize the trade. In effect, it is a type of pyramid scheme. In an unregulated OTC environment, there’s little to prevent this level of manipulation.
There are fewer safeguards that an unregulated broker won’t keep your personal information confidential, such as banking or payment information.
The OTC structure of Forex allows for both regulated and unregulated brokers.
Regulations offer traders the safety of capital through segregated client funds, fair trading practices and ensuring the financial stability of brokers. However, regulators may restrict leverage and market access, making it costly for brokers to obtain regulation.
That means unregulated brokers often offer higher leverage and access to a broader choice of markets. Many unregulated brokers allow for smaller account sizes, as well.
What is an unregulated Forex broker?
An unregulated Forex broker does not operate under the jurisdiction of any country’s financial regulatory body, meaning they have no rules or regulations to follow when providing Forex services.
Which brokers are unregulated?
Any broker that is not under the supervision of a country’s financial regulatory body is unregulated.
Can I use an unregulated Forex broker in the USA?
Yes, but the broker must be based offshore because US-based Forex brokers must be registered with the NFA & CFTC.
What is the difference between regulated and unregulated Forex brokers?
A country’s financial regulatory authority supervises a regulated broker. An unregulated broker does not operate according to rules or guidelines.