The Forex market is the largest, most liquid sector of the global financial system with a daily turnover of over $6 trillion; it is also the fastest growing one. Some governments, usually in emerging and frontier markets, ban retail Forex trading outright, while the majority regulate it so that Forex trading can be done in a safer environment for traders. When it comes to regulation, a fine line must be walked in order to ensure a fair market, protect traders, and allow innovation. Forex trading in Canada is regulated, but most Forex brokers cannot consider the Canadian regulatory environment as favorable, which explains why the country is not home to a high number of domestic brokers.
To better understand why most brokers prefer to set-up operations elsewhere and then attract Canadian traders, the regulatory environment in Canada needs to be better understood. Forex is either regulated as a security or a derivative, but the type of regulation differs as provincial and territorial securities and derivatives legislation applies in addition to federal regulation at the national level. This creates a challenge, whether a company wants to act as a broker or an advisor, as Canada lacks universal legislation for the entire country. From an operational perspective, this creates a quagmire.
Many people are surprised to learn that Canada has fifteen different regulatory bodies which regulate the Forex market. They include: the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC), while the remaining thirteen are provincial and territorial regulators. Having up to fifteen regulators further complicates operations for Canadian Forex brokers, while providing excellent protection for traders. Regulation can often be a double-edged sword: while necessary to create a fair and competitive market, it can also hinder innovation. A delicate balance is required, and Canada hasn’t really found it yet.
The Canadian Securities Administrators (CSA) is an umbrella regulator for all the provincial and territorial regulators across Canada. The goal is to improve, coordinate and harmonize the Canadian financial market as an informal body. The CSA mainly operates through meetings, conference calls, and daily cooperation among the 13 local regulators who exist in Canada. The CSA did create a passport system which granted access across all regulated provinces and territories to a firm, by dealing only through its main regulator; Ontario is the exception. This was meant to create more efficiencies through harmonized laws and make the Canadian market more competitive.
Every broker or advisor active in the Canadian Forex market must be regulated by the Investment Industry Regulatory Organization of Canada (IIROC). This self-regulatory organization was formed through a merger between the Investment Dealers Association of Canada (IDA) and Market Regulation Services Inc. on January 1, 2008. The Investment Dealers Association of Canada was originally formed in 1916 under then name Toronto Board of Trade with its primary objective to coordinate the financing of Canada’s war effort during World War I. It was renamed in 1934 and became the IDA.
While the IIROC is the main regulator for Forex trading, and has powers to fine, suspend or expel members by exercising quasi-judicial powers, it has been often criticized as an ineffective regulator. Another major area of criticism is that many laws have simply been copied from the U.S. which has further limited the global competitiveness of the Canadian financial market. The IIROC is active and conducts its share of surveillance in order to ensure that all members are compliant with its regulatory and investment standards, but this regulator had major regulatory failures to deal with: the worst may be the loss of unencrypted private investor data which led to an investigation by the CSA.
Private data from over 50,000 clients at 32 brokerage firms were stored on a mobile device which wasn’t encrypted and then lost. This violated IIROC terms and resulted in a review of security protocols. The IIROC has also been involved in litigation cases related to its disciplinary powers over former members and while this regulator cannot be blamed for being inactive, it may be regarded as inefficient or ineffective.
There is an extensive compliance system in place for all brokers and advisors to comply with, and compliance comes at a cost. As neither regulator is concerned with the associated costs on members as a result of regulation, rightfully so, Forex traders need to be aware that higher costs for brokers in order to be fully compliant may result in higher trading costs to them. Usually costs are passed on to consumers, this may come in the form of higher spreads or commissions.
One often overlooked fact about regulation is that it doesn’t protect against fraud as much as one might think. Some of the biggest fraud cases appear in the most regulated jurisdictions. For example, MF Global and PFG Best were heavily regulated US based brokers serving institutional clients, members of the National Futures Association (NFA) and regulated by the Commodity Futures Trading Commission (CFTC). The best-known broker in the retail sector caught in a major regulatory breach was FXCM, which lost its license and moved out of the U.S. Regulation plays an important role in global financial markets, but brokers who intend to defraud traders will do so regardless of regulation, and this may be equally true within Canada.
What do Canadian Forex Regulators Do?
In addition to regulating the Forex market, the IIROC also stipulates the maximum leverage a broker can offer to clients. Leverage has been a widely misunderstood trading tool and regulators across the financial system have taken steps to reduce maximum leverage while failing to spot the real problem: the lack of risk management coupled with false or misleading advertisements by brokers. The maximum leverage a Canadian-based broker can offer retail clients is currently between 1:45 and 1:50, subject to reviews and changes by the IIROC.
Many may regard this level as too high, but it should be noted that there is a big difference between advertised maximum leverage and leverage deployed. In addition, each broker has different margin requirements than the maximum allowed, based on assets traded. Canadian-based Forex brokers usually offer their highest leverage on Canadian Dollar pairs and then decrease the amount based upon liquidity of other currency pairs. Usually, a retail trader’s portfolio will have far less leverage than the maximum allowed.
The Canadian Foundation for the Advancement of Investor Rights (FAIR), is an independent national charitable organization which aims to be a voice for Canadian shareholders and investors in securities regulation. They frequently review rules and regulations and attempt to address them with the Canadian regulators and while their intent is to protect and enhance Canadian investors, not all their recommendations have that effect. It is worth noting that no regulator is required to engage with FAIR.
An additional layer of protection is offered by the Canadian Investor Protection Fund (CIPF). This insurance policy was created by the thirteen provincial and territorial regulators and all CSA brokers purchase this insurance; currently, there are over 170 firms who offer protection through the CIPF. The maximum coverage is CAD$1 million, but it is crucial to point out that this fund protects investors only from a bankruptcy of the brokerage. Investors who lose money through trading, fraud or other activities are not covered by the CIPF and won’t receive compensation.
There seems to be an over-abundance of regulatory bodies involved in the Canadian Forex market which is one reason few Forex brokers are based in Canada. The marketplace would put most at a disadvantage and most Canadian-based retail Forex traders are best served by brokers located elsewhere. This will usually result in better trading conditions and more effective regulation, and while Canada continues to work on improving its growing financial market, for the time being it remains far behind other jurisdictions.