Regulators (Finally) Get Around to Cleaning Up Israel’s Forex Market

After tabling regulation of companies offering trading in foreign currencies (forex) and related derivatives, the Israel Securities Authority has finally issued rules to rein in the heretofore unregulated cowboys and rascals who’ve changed the complexion of Ramat Gan’s boursa district.

As a Citigroup exec put it last year, FX brokers travel the globe in search of less regulation. They found it here. While not quite a Casablanca-like moment (“I’m shocked, shocked…”), it does seem that the ISA has only now woken-up to the problems that plague a fast-growing local industry that employs thousands.

Forex is an industry where perception and reality live on completely different planes. Surveys of current and potential retail FX traders show that 84% believe they can achieve positive monthly returns. In reality, only 30% of them make money, according to Citigroup.

So, what’s in store when the rules come into effect towards the end of May? Trading platforms are being required to get better at managing risk. They will now be required to allocate sufficient funds to support market risks, credit risks, liquidation risks and operating risks, as well as to develop and use techniques to manage risks, according to attorney Amir Scharf, a partner at Tel Aviv’s Tadmor & Co. Yuval Levy & Co.

First, all of the companies that operate in Israel or target Israeli clients must apply for a license. That would have seemed like a no-brainer that the ISA could have enacted as far back as 2010 when the regulator first set its sights on the activity of forex, binary options and other trading platforms. No license, no continuing operations in Israel. No license, face fines and possible imprisonment.

Second, the regulations require the trading platforms to determine the suitability of clients to the trading activities and associated risks. This process must be documented and should include questionnaires and other examination forms that enable the trading platform to evaluate the client’s understanding of the risks involved in the client’s activities. That process, based on personal experience, is a lot more involved than the practices of Israeli banks who spend little time asking about a customer’s financial history before extending credit lines in single-digit multiples of the monthly income.

Third, leverage is being tightened up, depending on the traded financial asset, to a low 20:1 of a high-risk trade’s value to a permitted leverage ratio of up to 100:1 of a low-risk trade’s value. Israel is catching up with the pack as most countries have or are discussing putting limitations on leverage, where rogue brokers advertise leverage of 1,000:1.

That’s damn attractive at first, but the downside is the killer: A trader with a small account, say $1,000 uses his 200:1 leverage, he purchases $200,000 EUR/USD. A not-unusual currency move of just 50 price interest points — the amount of change in the exchange rate for a currency pair — wipes out his account to a zero balance.

Fourth, and this is the hallmark of serious regulation, trading platforms are now required to submit to the ISA monthly reports, activity reports, credit risks reports, and market risks reports. The trading platforms are required to provide clients with transaction approvals, which include information regarding transactions executed and the accumulated balance of the specific financial asset following the execution of the transaction, bi-weekly and detailed monthly reports.

This is a huge step in creating transparency of these platforms and the industry. Now, if only the ISA would do the same for the unregulated and unsupervised forex trading at the major Israeli banks which is untouched by the new rules.

While ISA regulation can legitimately be criticized for stifling Israel’s capital markets and choking out new stock listings, here is a case where more is good. The result will be less harm to customers, cleaner operations by the companies, and a reputation boost to a sector that aspires to be part of the Tel Aviv fin-tech boom now taking place.