Broker is good, broker is bad

Part One. The danger of broker bankruptcy

How to understand whether the broker with whom we place our trading account is good or bad? How can a broker deceive us? What instruments of deception are available in the broker’s “pocket”?

The saddest thing is that the broker may turn out to be insolvent. Designation in English – insolvent. We will not be able to get trading capital back. This phenomenon rarely happens these days, but it does happen. Most brokers have no intention of stealing our money and running off “to the islands” to a mulatto beauty. The ideal option for most brokers is stable work and earnings on commissions for transactions. And by the way, many brokers are registered on these exotic islands, although they are physically present in other places (more on this below).

Insolvency, which sooner or later turns into official bankruptcy, arises mainly due to the risky trading operations of the broker himself. Most reputable banks have their own departments involved in trading financial instruments on various markets. These banks strictly follow the rules of limiting open positions, risk management and do not allow their traders to “play too much”. But even in reputable banks there were cases when traders “hide” their losses, which led to financial losses (we will describe these cases in one of the posts).

Small brokerage companies usually make money only from commissions. Most of them do not trade with their own money. But if they start trading, and trade at a loss, sooner or later the broker will need money to cover these losses. And he can take his clients’ money (rarely) since this is outright fraud, but in one way or another lead his company to insolvency (bankruptcy). However, for other reasons, both the brokerage firm and the bank may go bankrupt. In this case, you must be sure of the amount that will definitely be returned to you from the state, the regulator of the activities of this bank or company. Deposit Guarantee Fund

In all developed countries there is a Financial Service Authority (FSA), an analogue of the Central Bank of the Russian Federation, which regulates the activities of banking institutions, as well as investment companies. However, as for investment companies, as well as Forex brokers, each country may have a separate regulator that regulates and supervises their activities. The Bank of England has a department called the Prudential Regulation Authority, which regulates and supervises more than 1500 banks, investment companies, insurance companies, and credit unions. In the UK, functions in the field of permits and supervision are also carried out by the FCA (Financial conduct authority), an organization that protects the rights of investors in financial markets, monitoring the integrity of brokers and other enterprises involved in working with clients. Similar organizations exist in other European countries. Brokers, after checking compliance with the requirements, receive a registration number from the FCA, which you can see on the broker’s website, for example:

(Company Name) is authorized and regulated by the Financial Conduct Authority in the UK. It appears on the FCA’s Register with registration number is ХХХХХХХ. Further information may be obtained from the FCA’s Register by visiting the FCA’s website: https://www.fca.org.uk/.

The same FSA in Germany:

(Company name) is a company licensed and regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) under registration number ХХХХХХХ. Further information may be obtained from the BaFin’s Register by visiting the BaFin’s website

As you understand, obtaining a license to create a bank in England is a feat comparable to flying to the moon😊

Each foreign BANK, including those engaged in investment activities, has on its website (must have) a link or in the FAQ a designation of the amount in which they guarantee the return of the client’s funds in the event of bankruptcy

For example: in EU countries, the FSA regulator will certainly pay up to 100k Euros per client for the obligations of a bankrupt bank. Everything else is hopeless. As you understand, there will be a long line of creditors. In the UK – 85 thousand pounds.

If you are opening a trading account with a foreign brokerage company (not an investment bank), you should pay attention to the following:

Typically, most EU and UK registered brokers operate under an investor protection scheme regulated by the local FSA. There are two options:

1. Unconditional coverage of your trading account by the FSA regulator in the event of broker bankruptcy for the full amount (100k Euros or 85k pounds)
2. In some countries or with a broker with a limited license (for example, cannot hold deposits and the like), the FSA separates the “cuts from the flies”, that is, your money is held by an authorized bank, and the broker only temporarily disposes of it to service margin requirements your trading positions. Read the broker’s guarantees carefully. Sometimes it happens that a European broker does not have a full license for all operations, but they use a completely normal scheme described above, however, compensation in case of bankruptcy will not exceed 20k EURO.

An important “label”: having a European broker license.

EU Directive 2004/39/EC on Markets in Financial Instruments Directive (MiFID or MiFID I) allows investment advisors, securities brokers and Forex service providers licensed in one European Union (EU) member state to offer their services all across a single EU/EEA financial market of 27 states.

If an investment bank or broker states on its website that it has a MiFID license, it is a certified broker that has the right to serve clients from all 27 EU countries. Does this license add confidence to the broker or bank? To a certain extent, yes. In addition, no broker registered in the EU countries can operate without a full or limited license.

In the next post we’ll talk about other “features” of brokers that are available to everyone without exception. Regardless of the country of registration.