EU Regulation
The online trading industry within the European Union is overseen by ESMA (European Securities and Markets Authority). This authority is the EU’s financial markets regulator and supervisor. One of ESMA's main objectives is to protect consumers (retail investors and traders) which it tries to achieve through various steps.
Negative balance protection
Probably the most important aspect of client protection that ESMA has put into practice. Let’s say that the client in our previously mentioned example had a really unfortunate trade and now faces a loss exceeding his account balance, due to the reckless usage of financial leverage. In a normal situation, common sense would tell us that he will go into debt. Luckily, our trader chose to trade with an EU-regulated broker. This means he will not go into debt. This is because, thanks to the negative balance protection, a client of an EU-regulated broker cannot lose more money than he has deposited in his trading account.
Reduced financial leverage
Financial leverage allows investors and traders to open multiples of trading positions and trade a larger volume of transactions than with their own money. Thus, in case of a successful trade, leverage multiplies the result, but it works the same way in case of a loss.
It is the financial leverage that is a big attraction, for many traders. But trading on the financial markets is not a simple matter and the combination of lack of experience and financial leverage can quickly cost beginners their money.
That's also why ESMA set the leverage limit for retail clients in the EU at 1:30 in 2018, and higher leverage (up to 1:400) can only be provided by brokers to clients who have met a number of criteria for Professional Client status.
Segregation of client deposits
As we mentioned in the minor historical throwback at the beginning of our article, the Forex industry and online trading, in general, have come a long way since its beginnings. In particular, the industry's unregulated beginnings have sometimes led to brokers using capital from client deposits to fund their operations and even to cases of embezzlement.
ESMA, therefore, supervises brokers operating in the EU to ensure that client deposits are protected. One way is by depositing client funds in separate bank accounts. Brokers cannot use client deposits to fund their operations. Thus, situations similar to the early days of online trading cannot be repeated.
KYC regulation (know your customer)
This is a regulatory requirement in order for Brokers to identify their clients. If you have ever opened an account with a broker and been frustrated by the number of personal documents and proof of income documents you had to provide during registration, then they were probably an EU-regulated broker.
The goal is to prevent money laundering, fraud, and even terrorist financing. By relying on these rules, a broker can be a little more confident that its services are not being used by clients for nefarious purposes.