Negative Balance Protection in Forex Trading
- Negative balance
- Negative balance protection
- Countries and regulators offering negative balance protection
- Countries and regulators prohibiting negative balance protection
- Brokers with negative balance protection
It is important for a Forex trader to understand the concept of negative balance protection (NBP). But to understand it, one needs first to know what a negative balance is. As it can be guessed from the name, a negative balance means that funds in your Forex broker account fall below zero. In other words, you owe the broker money. Let's look at an example. You have $1,000 in your account and open a position with 1:10 leverage. Then the market falls 15%, meaning that you lose $1,500. So not only you have lost all your money but you also now owe the broker $500.
There are various ways to avoid a negative balance. Brokers can initiate a margin call, requesting a trader to deposit more funds to his account in order to avoid a negative balance. One of the best ways for a Forex trader to avoid significant losses, including those that would put his account balance into negative, is to employ
Negative balance protection
To avoid putting traders in debt, some brokers offer negative balance protection. As one can guess from the name, it prevents the balance from falling into negative territory. In the previous example, a loss of $1,500 will wipe out $1,000 from your account but it will not result in debt if the account is protected by the NBP. The advantage of such protection for retail traders is obvious: they should not worry about getting into debt regardless of how big swings on the market are.
Yet there are also drawbacks of such protection, primarily for retail brokers. Being considered professional clients by liquidity providers, brokers do not have a benefit of NBP offered to retail clients. And that can seriously hurt retail Forex brokers. For example, if two traders with a $1,000 account each open a position in EUR/USD, one short and another one long. The pair moves up, resulting in a $5,000 gain for the first trader and a $5,000 loss for another. Usually, those trades will cancel each other for a broker. But with NBP, the unfortunate trader will lose $1,000 from his account but the rest of $4,000 is now a liability for the broker. To mitigate such risks, brokers may increase their fees, meaning that their clients essentially pay for negative balance protection.
The big swings of EUR/CHF after the pegging and then unpegging the Swiss franc to the euro by the Swiss National Bank led to worries about risks that market volatility poses to traders. That prompted regulators in some countries to require NBP for retail clients from Forex brokers. Let's look at what regulators have such a requirement and how it works.
Countries and regulators offering negative balance protection
European Union — European Securities and Markets Authority
The European Securities and Markets Authority (ESMA) is a regulator that oversees markets in the European Union. In March 2018, it announced a range of measures intended to protect investors, including several restrictions on contracts for difference (CFDs). Among such restrictions was
Cyprus — Cyprus Securities and Exchange Commission
The Cyprus Securities and Exchange Commission (CySEC) is a regulator that supervises the investment services market, securities transactions, and the investment and the asset management sector in the Republic of Cyprus. It was ahead of the curve compared with the ESMA and other regulators, introducing negative balance protection as early as November 2016. It clarified further in September 2017 that the protection is on a per-account basis. Being part of the European Union, Cyprus applied the ESMA regulations considering retail investor protection, including rules for NBP, when they came into effect. In September 2019, the CySEC issued a separate regulation that made the ESMA restrictions on CFD trading permanent.
Malta — Malta Financial Services Authority
The Malta Financial Services Authority (MFSA) is the single regulator of financial services in Malta. It implemented permanent restrictions on CFD trading similar to those of the ESMA, including negative balance protection, in August 2019.
United Kingdom — Financial Conduct Authority
The Financial Conduct Authority (FCA) — regulates financial services firms and financial markets in the United Kingdom. In July 2019, the FCA announced measures intended to protect retail investors. Among the announced measures was negative balance protection. The announced restrictions on CFDs (including rolling spot Forex) and CFD-like options are very similar to that of the ESMA, which is not surprising considering that the UK was still in the EU back then. The regulation applies to all MiFID investment firms, which distribute, market, or sell CFDs and CFD-like options. Under the regulation, a trader cannot lose more funds than he has in his or her account. The regulator further specified that the funds in the account mean funds specifically dedicated to the restricted speculative investments. That includes cash in the account and any unrealized net profits from open positions but does not include funds and other assets in the trader's account that are not dedicated to trading in the restricted speculative investments.
Australia — Australian Securities & Investments Commission
The Australian Securities & Investments Commission (ASIC) — is Australia's regulator that oversees, among other things, financial services and markets. It took longer than other regulators for the ASIC to start demanding negative balance protection but, ultimately, the market volatility during 2020 made the ASIC implement protective measures similar to other regulators. Starting March 2021, a range of measures intended for retail investors' protection came into effect. Among them was NBP. The restrictions applied to any Australian firm or a firm operating in Australia that deals with CFDs. That includes all regulated Forex brokers. Under the regulation, the trader's liability cannot exceed the total amount of money and property held in the trader's account in relation to the CFD trading account.
Countries and regulators prohibiting negative balance protection
United States of America — Commodity Futures Trading Commission
The Commodity Futures Trading Commission (CFTC) regulates the US derivatives market. Unlike the previously discussed regulators, it does not require negative balance protection from Forex brokers. In fact, the opposite is true: it prohibits such protection outright. Under the CFTC regulation 5.16, no retail foreign exchange dealer, futures commission merchant, or introducing broker is allowed to protect retail Forex traders against loss, including guaranteeing against, limiting, assuming, or sharing trader's loss. The CFTC states that in case the loss exceeds the initial margin deposit the trader is responsible for covering the loss with additional funds. The CFTC filed its first enforcement action against a registered retail foreign exchange dealer for a violation of the regulation in August 2016.
Japan — Financial Services Agency
The Financial Services Agency (FSA) regulates the financial system, financial institutions, and securities transactions in Japan. Just like the CFTC, it forbids retail Forex brokers to offer negative balance protection to their clients. It is often criticized for such a stance as it can lead to significant losses for retail traders. For example, the flash crash of the Japanese yen currency pairs on the first trading day of 2019 led to huge losses for traders. But brokers suffered as well because many of them were unable to procure additional funds from their clients to cover the negative balance in their accounts. As a result, the total losses suffered by Japanese STP brokers totaled about $8.6 million.
Brokers with negative balance protection
Negative balance protection has obvious benefits to Forex traders, especially inexperienced ones, though any type of trader would be happy to be protected from extraordinary situations, in which usual methods of risk mitigation might not work. Yet as was discussed previously, brokers offering protection for their clients' funds may require higher fees to offset the risk they take offering NBP.
Needless to say, brokers registered with regulators, which demand protection of retail traders' funds, offer NBP. But there are also brokers which offer negative balance protection even being registered in countries that do not have such a requirement. It is important to remember that usually, such brokers either do not operate in countries that prohibit the protection of traders' funds or do not offer NBP to traders in those countries. Here is a list of several Forex brokers that offer negative balance protection even though their regulators do not require it.
RoboForex Ltd is a Forex broker regulated by the IFSC Belize. It does not offer services in the EU as well as a range of other countries, including the USA, Canada, Japan, Australia, and others. The broker states on its site that it offers negative balance protection. Yet the Client Agreement says that the client should pay within two business days any amount that exceeds the equity of the account. Such phrasing does not sound like the broker is actually going to zero out the negative balance on the account. Responding to the request for clarification, the broker said that it has negative balance protection, though it reserves the right to exclude accounts from the program, meaning that the account must be deposited before further trading is possible.
easyMarkets is a trading name of EF Worldwide Ltd which is licensed by the Financial Services Authority of Seychelles. The company also has subsidiaries that are licensed by various other regulators, including the CySEC. The broker's website specifically mentions that the broker is not under the supervision of the JFSA and therefore does not provide services for residents of Japan. Additionally, the broker does not provide services in a significant number of other countries, including the United States of America and Israel. The broker's website states that easyMarkets provides negative balance protection and explains why such protection is important. Indeed, the Open Execution Policy, listed in the Legal Documents portion of the site, states that "in case the client balance goes negative after all positions close, the Company will cover the negative balance and will not request from Clients to cover the required amount".
XM.com is a Forex broker operated by XM Global Limited, which is a member of Trading Point Group and is licensed by the International Financial Services Commission (IFSC) in Belize. The group also has a branch that is authorized and regulated by the CySEC. XM.com does not provide services for residents of some countries, including the United States of America, Canada, Israel, and the Islamic Republic of Iran. In its Terms and Conditions, the broker specifies that it offers negative balance protection on a
IC Markets is a Forex broker registered with several regulators, including the CySEC and the ASIC. Its global branch is regulated by the Seychelles Financial Services Authority. The broker's website states that the information on the site is not intended for residents of the USA, Canada, Israel, New Zealand, Japan, and Iran, suggesting that the broker does not provide services for residents of those countries. On some broker lists, IC Markets is mentioned as a broker offering negative balance protection. Of course, the European and Australian branches offer such protection due to the requirements of regulators in the European Union and Australia. The situation with the global branch is more complicated. The FAQ section on the site says in regards to NBP that "you are protected from having your account go into the negative and will quickly return to a zero balance". Yet the Terms and Conditions do not mention the NBP at all. On the contrary, the document states: "We have the right (at any time) to set off any losses incurred or any amounts you owe in respect of your Transactions or any debit balances in any Account. If any loss or debit balance exceeds all amounts held, you must immediately pay us any excess whether demanded or not." Responding to the request for clarification, the broker said that all account holders have negative balance protection, meaning that any negative balance will be zeroed out.
FXChoice is a Forex broker regulated by the IFSC of Belize. The broker states that it has negative balance protection, though it is not on a
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