Following up on How to tell if a broker is regulated, here’s the answer to another classic: is my forex “broker” really a broker, or a dealing desk?
NB: if you’re unsure why brokers and dealers (market makers) tick differently, watch this webinar. All we do here is get the regulator to tell you what’s what, in language meant for traders, not lawyers. Our goal is to explain stuff clearly, but if you think any of the below is incorrect or misleading, comment below & accept our apologies!
1. Activities: certain financial activities fall within the regulated perimeter – i.e. to carry them out, persons have to 1) apply for regulatory permission and 2) agree to abide by the regulations. These include, amongst others, whom you employ (are they fit and proper?), how you advertise, how much regulatory capital you must hold, your internal processes, etc.
2. Instruments: not all financial instruments are equally risky – thus the regulator verifies on what instruments the regulated person is fit to carry out the regulated activity
3. Customer type: not all customers are equally vulnerable to financial abuse. Goldman Sachs can reasonably be expected to know the risks in trading with leverage, in a way that e.g. your average 93 year old pensioner cannot.
Because one of the goals of regulation is protect vulnerable economic agents from unfair treatment – the demands on agents offering trading of high risk instruments are proportionately higher.
Right! Why, then, does someone like Darwinex claim to be a broker, but carry permission to deal as principal?
Because spot foreign exchange or contracts for difference, or spread-bets are traded over the counter. OTC instruments are not available from any of the Exchanges recognised by the FCA, so there’s NO organised market for an agent to source them for you. To get around this, every European broker (even agency-only ones) offering OTC instruments needs permission to “Deal in investments as principal”.
So, every European forex / CFD / spreadbetting broker could be trading against me?
NO! Some remain agency only by limiting their dealing in investments as principal permission with a “matched-principal” restriction (click on the image below to visit Darwinex’s regulatory profile) as per below.
This imposes on Brokers the “matched-principal” trade flow:
1. Customer goes LONG 1 Lot EURUSD…
2. Broker goes SHORT 1 Lot EURUSD (using the “Dealing in Investments as Principal” permission)…
3. At the same time, matched-principal brokers go LONG 1 Lot EURUSD against independent liquidity providers – aka “the market”.
Note that all a dealer could do to internalise the customer P&L (internalise = fancy word to say that dealers win when customers lose, and viceversa) is NOT enter the matched-principal, market facing trade leg. With a matched-principal broker, after the third “with-customer” trade leg:
1.The customer is LONG the EURUSD.
2. The market is SHORT the EURUSD against the customer, via the broker
3. The matched-principal-broker is trading with the customer, against the market. At heart, he remains an agent despite acting as a principal on the customer leg. This is the only way to source OTC investments on a pure agency basis in Europe
As a relevant side-note, notice the nuance on incentives:
1. First order, the broker doesn’t care how the EURUSD moves, as his P&L is the net offset of 2 other principals (customer and market). This is the reason why pure brokers trade market risk for counterparty risk – and if you want to understand the implications watch this.)
2. Second order, brokers prefer winning customers – they trade bigger volumes, for longer than losing customers, which means more commission
That’s it: to tell a dealer from a broker, all it takes is ask the FCA.
No matched-principal restriction? It’s a dealing-desk / market maker / dealer. By the way, the FCA requires 5 times more regulatory base capital from dealers than for matched principal brokers. If told by a “broker” that they carry the dealing permission just in case, you know the next question to ask.
NB: if you’re unsure why brokers and dealers (market makers) tick differently, watch this webinar. All we do here is get the regulator to tell you what’s what, in language meant for traders, not lawyers. Our goal is to explain stuff clearly, but if you think any of the below is incorrect or misleading, comment below & accept our apologies!
A (minimal!) primer on European MiFID regulation
Broadly speaking, European MiFID regulation involves 3 dimensions when it comes to trading:1. Activities: certain financial activities fall within the regulated perimeter – i.e. to carry them out, persons have to 1) apply for regulatory permission and 2) agree to abide by the regulations. These include, amongst others, whom you employ (are they fit and proper?), how you advertise, how much regulatory capital you must hold, your internal processes, etc.
2. Instruments: not all financial instruments are equally risky – thus the regulator verifies on what instruments the regulated person is fit to carry out the regulated activity
3. Customer type: not all customers are equally vulnerable to financial abuse. Goldman Sachs can reasonably be expected to know the risks in trading with leverage, in a way that e.g. your average 93 year old pensioner cannot.
Because one of the goals of regulation is protect vulnerable economic agents from unfair treatment – the demands on agents offering trading of high risk instruments are proportionately higher.
Broker activities & permissions
The minimum set of regulated activities – and therefore, MiFID permissions – involved in legally operating a European brokerage are:- Agreeing to carry on a regulated activity –
- Making arrangements with a view to transactions in investments
- Arranging (bringing about) deals in investments
- Arranging safeguarding and administration of assets
- Dealing in investments as agent
- Dealing in investments as principal
- Given you’re looking for a broker, did you spot the odd permission out?
Brokers dealing as Principals???
A broker ought to be an agent – not a principal – to customer trades! Surely anyone dealing in investments as Principal can’t be a broker?Right! Why, then, does someone like Darwinex claim to be a broker, but carry permission to deal as principal?
Because spot foreign exchange or contracts for difference, or spread-bets are traded over the counter. OTC instruments are not available from any of the Exchanges recognised by the FCA, so there’s NO organised market for an agent to source them for you. To get around this, every European broker (even agency-only ones) offering OTC instruments needs permission to “Deal in investments as principal”.
So, every European forex / CFD / spreadbetting broker could be trading against me?
NO! Some remain agency only by limiting their dealing in investments as principal permission with a “matched-principal” restriction (click on the image below to visit Darwinex’s regulatory profile) as per below.
This imposes on Brokers the “matched-principal” trade flow:
1. Customer goes LONG 1 Lot EURUSD…
2. Broker goes SHORT 1 Lot EURUSD (using the “Dealing in Investments as Principal” permission)…
3. At the same time, matched-principal brokers go LONG 1 Lot EURUSD against independent liquidity providers – aka “the market”.
Note that all a dealer could do to internalise the customer P&L (internalise = fancy word to say that dealers win when customers lose, and viceversa) is NOT enter the matched-principal, market facing trade leg. With a matched-principal broker, after the third “with-customer” trade leg:
1.The customer is LONG the EURUSD.
2. The market is SHORT the EURUSD against the customer, via the broker
3. The matched-principal-broker is trading with the customer, against the market. At heart, he remains an agent despite acting as a principal on the customer leg. This is the only way to source OTC investments on a pure agency basis in Europe
As a relevant side-note, notice the nuance on incentives:
1. First order, the broker doesn’t care how the EURUSD moves, as his P&L is the net offset of 2 other principals (customer and market). This is the reason why pure brokers trade market risk for counterparty risk – and if you want to understand the implications watch this.)
2. Second order, brokers prefer winning customers – they trade bigger volumes, for longer than losing customers, which means more commission
That’s it: to tell a dealer from a broker, all it takes is ask the FCA.
No matched-principal restriction? It’s a dealing-desk / market maker / dealer. By the way, the FCA requires 5 times more regulatory base capital from dealers than for matched principal brokers. If told by a “broker” that they carry the dealing permission just in case, you know the next question to ask.
Editors’ Picks
EUR/USD eyes nine-day EMA barrier after rebounding from 1.1600
EUR/USD gains ground after registering modest losses in the previous session, trading around 1.1620 during the Asian hours on Friday. The technical analysis of the daily chart suggests an ongoing bearish bias as the pair remains within the descending channel pattern.
GBP/USD drifts lower heading into NFP range
GBP/USD edged lower by 0.2% on Thursday, settling close to 1.3350 in a strained trading session that kept the pair pinned near three-month lows. Price briefly recovered earlier in the day on reports that Iran had indirectly signaled openness to talks with the CIA, but the bounce faded as Israeli officials reportedly advised Washington to disregard the overture.
USD/JPY struggles near 157.50, eyes turn to US NFP
USD/JPY edges lower to near 157.50 in the Asian session on Friday after posting modest gains in the previous session. Broad US Dollar weakness, Japanese FX intervention risks and a risk-off market mood undermine the major, despite uncertainty over the BoJ interest rate hikes. All eyes now remain on the US Nonfarm Payrolls data.
Editors’ Picks
AUD/USD bounces back toward 0.7050 amid renewed USD weakness
AUD/USD stages a comeback toward 0.7050 in Friday's Asian trading, after falling about 1% on Thursday. The pair draws support from a fresh selling wave seen around the US Dollar even as risk sentiment remains weak. Surging oil prices due to the Middle East war dent risk appetite.
USD/JPY struggles near 157.50, eyes turn to US NFP
USD/JPY edges lower to near 157.50 in the Asian session on Friday after posting modest gains in the previous session. Broad US Dollar weakness, Japanese FX intervention risks and a risk-off market mood undermine the major, despite uncertainty over the BoJ interest rate hikes. All eyes now remain on the US Nonfarm Payrolls data.
Gold awaits US Nonfarm Payrolls for a clear directional impetus
Gold rebounds above $5,100 early Friday after testing the $5,050 level amid global sell-off. The US Dollar pulls back as profit-taking creeps in ahead of US labor data. For February. 21-day SMA holds amid bullish RSI; a daily closing above 61.8% Fibo is critical for Gold buyers.
Ethereum pull in $169M as validators pile in to stake ETH
US spot Ethereum exchange-traded funds recorded $169 million in net inflows on Wednesday, marking the largest daily intake in two months, according to SoSoValue data. The rise in inflows signals renewed institutional interest in Ethereum amid broader market volatility.
The market compass is pointing at a barrel of Oil
The Asian open is arriving with equities leaning the wrong way, and the reason is not complicated. The market’s compass needle has snapped firmly toward crude. In this tape, oil is not just another input price; it is the gravitational center around which every asset class is orbiting.
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