Leverage can be a tricky discussion to have with retail Forex traders, undoubtedly, if used correctly leverage can magnify your gains, if leverage is used badly then losses can become increased to the point where margin calls are invoked and or accounts are closed. Many traders use leverage recklessly. They’ll see an option for 1:200 (or more) and immediately select it, controlling €200 for every €1 has an obvious appeal, particularly for traders who are controlling small accounts, who are extremely impatient to progress and take money out of the market.
USA authorities limited leverage to 1:50 on the major currency pairs and 1:20 on the minor currency pairs as far back as 2010. The decision caused quite a shakeup in the USA Forex retail industry and it wasn’t as simple as traders moving offshore, that’s considered a form of evasion and illegal under U.S. law. However, whilst there is evidence that many traders gave up retail trading in the USA as new margin and leverage levels were implemented, many retail traders simply continued to trade under the new rules, they took on board the new framework as a challenge and adapted. An argument could be put forward that it concentrated minds and forced part time traders and those with small accounts, to move towards a more thorough and professional approach, ultimately taking the activity and for some the occupation, more seriously.
In Japan leverage has been restricted to 1:25, and in December 2016 many U.K. based spread betting firms saw their share price collapse as the FCA began a consultation process suggesting that leverage for inexperienced traders should be limited to 1:25 and for experienced traders, or those who could be classed as professional, a limit of 1:50 could be set.
The European Securities Markets Authority (ESMA) has been inviting opinions during its consultation period regarding proposals that could take leverage down to 1:30 across the board, given that the U.K. FCA were proposing up to 1:50, this could put the U.K. in conflict with its European supranational financial regulator. Leading spread-betting firms in the U.K. wanted the leverage limit to be set at 1:100, a significant gap from where ESMA are considering placing the limit and the FCA proposals.
Many European brokers and particularly the U.K. based spread betting firms, have been furiously lobbying their clients and the authorities to keep any reduction in leverage and as a consequence the margin required to trade, moderate. Many brokers have suggested that it’d be harmful for clients as many Forex traders might move offshore and trade in jurisdictions that offer little protection. However, the logic of this doesn’t make sense, why would traders take unnecessary risks with the safety of their funds simply to chase increased available leverage? Moreover, if the leading developed Forex areas; the USA, U.K., Japan, Europe and Australia are unified in their leverage levels and develop a coordinated consensus regarding client safety, then surely that would represent a huge leap forward in terms of safety for all Forex traders globally?
A theme regarding the global protection of consumers trading Forex is developing between central banks, therefore a link between the banks and financial conduct authorities, could ensure that the Forex industry is harmonized further. The BoE and six EU central banks have recently signed up to FX Global Code. The UK central bank has now formally committed to the FX Global Code of Conduct, following the ECB and 14 other peers.
The BoE’s press release:
“By issuing these statements of commitment, the bank is demonstrating that it is committed to adhering to the principles of these codes when acting as a market participant in the relevant markets, and that its internal practices and processes are aligned with the principles of the codes. The principles of these codes are important in promoting the integrity and effective functioning of these respective markets.”
An argument could also be put forward that ESMA is seeking to protect clients. There is an opinion that far too many traders come to the market poorly capitalized with very little understanding of margin and leverage and have very little understanding of how markets work. Even in a rising market they fail to take the necessary caution. Therefore reducing leverage may in fact produce an indirect and unforeseen benefit to new clients who are considering speculation as a method to bolster their investment growth, or as a career.
Story Contribution: Senior market analysts from FXCC (an ECN FX broker) contributed in this story.