CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. The vast majority of retail client accounts lose money when trading in CFDs. You should consider whether you can afford to take the high risk of losing your money.

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14 April 2020

Protections in Volatile Markets under FCA Regulations

All traders appreciate the relationship between risk and reward. Volatile markets provide both risk and potential reward in abundance. However, it is not the role of regulators to advise you on how to manage your potential market risk. The regulators, however, do require that authorised Financial companies to warn you of the potential risks and, in the case of CFD trading, to actually quantify the risk, as a percentage of customers who lose money, on their platform. Nevertheless, a number of protections have been put in place by the regulator to provide some peace of mind to investors, especially the retail investors. The most important one is actually only available to retail investors and is the Negative Balance Protection.

This was bought in by ESMA to protect retail investors in 2018 and subsequently adopted by FCA. It obliges brokers to ensure that retail investors do not lose more money than they have invested. On the face of it this sounds like a rather pointless regulation as in normal markets, clients’ positions would be closed out before their balance dropped below zero. Commentators were regularly heard saying that this regulation would only have effect if a Black Swan event occurred. A Black Swan event is defined by Investopedia as:

“An unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences. Black swan events are characterized by their extreme rarity, their severe impact, and the widespread insistence they were obvious in hindsight.”The reaction of Financial Markets to COVID-19 obviously shares a good number of the characteristics of a Black Swan event and therefore the Negative Balance protection is now very relevant.

In exceptionally volatile markets there is a risk that a close out order is not able to be enacted because there is basically no trade at that price. This is because the market can gap. This leaves you at risk when, despite your and your broker's best efforts, your account goes into negative territory. What this protection does is to ensure that the Broker is held responsible for any negative balances and the retail clients will not be accountable for any losses below zero on your account.

Given the hugely volatile markets that are almost undoubtedly going to be the norm for the foreseeable future it is very important for retail investors to check that you are with a regulated broker and that you are covered by the Negative Balance Protection.

The two further protections are more aimed at the safety of the funds deposited with regulated Financial companies. The first of these is the Segregation of Funds. The purpose of the segregation of clients' funds from those of the companies is to protect the client. An FCA authorised firm is governed by the FCA's rules, especially the Client Money Rules for the way in which they hold and deal with clients' money.

These rules require that clients' monies are held in a separate bank account to that of the company's money. The bank accounts that hold the client monies are established with FCA prescribed acknowledgment letters in which the Bank recognises that the funds are held in trust for the client and is separate from the company’s.The final protection is the Financial Services Compensation Scheme (FSCS) which was set up in 2001 having being established under the Financial Services and Markets ACT 2000 (FSMA). It is a non-profit-making independent body which is financed by levies on authorised financial services firms. The scheme's rules are made by the FCA and are contained in their handbook.

The FSCS is the UK's statutory deposit insurance and investors compensation scheme for customers of authorised financial services firms. In simple terms this means that the FSCS can pay compensation to the customers of a firm if it is unable, or unlikely to be able, to pay claims against them.

The cover has been increased to GBP 85,000. This is the maximum amount that can be compensated to each individual client of each financial services firm. Please note though that the cover is for each individual not each account.

Indeed, there are protections in volatile markets but these are only available to clients of firms regulated and authorised by the FCA. So, be mindful when choosing online forex brokers, it is strongly recommended that you go for FCA authorised and regulated firms like USG UK which can provides you with the protections that you need.

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