Choosing a Forex Broker in 2019 Post-ESMA New Regulation (Europe)

The face of retail forex trading has been altered forever with the passage of new rules regarding margin requirements and stop out levels released by the European Securities Markets Authority (ESMA).

You can consider this the fallout of the January 15, 2015 tsunami that swept the forex market when the Swiss National Bank (SNB) de-pegged the Swiss Franc from the Euro. At least two notable brokers went insolvent, and many traders lost their entire accounts. The reason was simple: high leverage caused traders to have too much market exposure, which ultimately affected brokers who were unable to contain the damage from the slippage that occurred. Only brokers that reduced leverage (some to as low as 1:10) came out of the event with a few scratches here and there. Ever since, brokers have come up with a strategy of lowering leverage given to traders on certain assets facing heavy market volatility at certain times (such as during the Brexit vote, French elections and US elections). But ESMA was worried about the bigger picture: protecting traders and brokers from themselves as it were. So it has come up with new rules regarding FX trading, binary options and CFD trading.

  • Trading on FX Majors now carries a leverage maximum of 1:30. FX Minors, gold, indices and stock CFDs now come with a leverage maximum of 1:20. Crude oil CFDs carry a maximum leverage of 1:10. Extremely volatile stocks will see leverage pegged at a maximum of 1:5.
  • Stop out levels have been increased to 50% of trading accounts. This enables brokers to apply margin calls a lot earlier than before.
  • Provision of negative balance protection is now mandatory. This is to forestall the nasty occurrences of brokers asking traders to pay for the negative balances on their accounts following the January 2015 Euro-Swiss Franc floor collapse.
  • Binary options and bonuses are banned.
  • Brokers are now mandated to make a disclosure on their home page on the profitability percentage of their trading clientele in the last 12months.

Forex Broker Choices Post-ESMA

Choosing a Forex Broker in 2019 Post-ESMA New Regulation (Europe)

ESMA’s new regulations cover the whole of Europe, and this includes brokerages located in Cyprus, Germany, United Kingdom, Malta and other European countries. Limiting leverage that brokers can provide to traders and increasing margin requirements is going to have a double-edged effect on both traders and brokers. Traders now need a lot more capital to be able to trade FX and CFDs on European brokerage platforms. This will weed out a lot of traders with small capital from the European brokerage ecosystem. Of course, the new rules cannot suppress the need by these traders to trade forex, so they will simply move to other jurisdictions where high leverage is still provided. For brokers, this will also lead to a loss of clientele and revenue shortfalls that will need to be balanced out. Some brokers with multiple branches within and outside Europe have already found a way out of the quagmire; they are transferring such clients to their non-European branches in Mauritius, Australia, Seychelles, Vanuatu and other offshore locations. Brokers that are only based in Europe do not have such luxury and they will undoubtedly be the hardest hit.

Choosing a Forex Broker Post-ESMA

For retail traders who have hitherto used European brokers for their business, there are only two options left when it comes to choosing a best forex broker.

The first option is simply to migrate to other jurisdictions. If you have an account with some of the older brokers who have multiple branches within and outside Europe, things will be made easy for you. Your broker will send you an email or prompt you to have your account transferred to one of their offshore locations. If you want to open a new account, you will be prompted to open an account with the non-European branch of the brokerage; if they have one that is. But if the broker does not have a non-European branch, you will have to look for an offshore broker to handle your business. This is very tricky as many standalone offshore brokers are either totally unregulated, or do not operate under the same strict regulatory frameworks that guarantee total trader protection. So in essence, you will find yourselves in the wilderness and you have to do your best not to fall into the hands of the bad guys. The best bet here is to stick with ESMA-regulated brokers that operate non-EU branches. These guys typically have regulated offshore operations as well and generally try to adopt the same fairness with which they would handle their EU-clients. For them, brand protection is everything and this is a factor that will work in your favour.

The 2nd option is for those who want to continue trading with the European brokers, who have by now started the implementation of the new rules. To trade with an ESMA-compliant broker, you will need much higher capital to trade even 1 mini-lot positions. Here is an illustration.

1 mini-lot of GBP/USD costs £10,000. Using a leverage of 1:30 (i.e. 3.3% or 0.033) would need a margin of £10,000 X 0.033 = 330. The current exchange rate of the GBP to the USD is £1 to $1.2742, so you would need $420.47 (i.e. 330 X 1.2742) to setup a 1 mini-lot position.

Under previous leverage conditions where traders could use leverage of 1:500 on EU broker platforms, it would require just $10,000 X 0.002 or $20 to setup such a trade. So if you had a $1000 as account capital, you could trade 1 mini-lot and still be within the 3% risk exposure limit. Not anymore. Now you would need at least $12,000 in your account to be able to trade 1 mini-lot and still be within risk exposure limits.

So when making your choice of a forex broker, consider the following:

  1. Can you muster the new account capital requirements that would keep you within risk exposure limits?
  2. If your answer to the above is no, can you safely choose an offshore broker, or would you prefer to trade with an offshore branch of an EU-regulated broker?

Perhaps another factor to consider would be the profitability disclosure which is now a mandatory requirement for all EU brokers. Would it be wise to choose brokers with the highest profitability, or is a better pathway to find out what is making traders more profitable on certain platforms than others? These are questions that should guide your forex broker choices in 2019, following the new regulations.

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