EU policies for investor protection explained

Novice investors are highly susceptible to falling into money traps. Even experienced traders and investors can become victims of scams. In order to protect their citizens, regulators in developed countries implement rules and policies.

In Europe, there are various regulatory bodies that license brokerage and investment firms. Strict regulators demand from brokers to implement tools and policies that will protect investors’ funds: like negative balance protection, segregation of bank accounts, and offering a sensible leverage. In addition, strictly regulated brokers are a member of investor’s compensation scheme.

The list of European regulators includes:

  • ESMA – European Securities and Markets Authority
  • FSMA of Belgium
  • FSC (Financial Service Authority) Bulgaria
  • CFSSA of Croatia
  • CySEC of Cyprus
  • FCA – Financial Conduct Authority of the United Kingdom
  • BaFin of Germany
  • FMA of Liechtenstein
  • CSSF of Luxembourg
  • FINMA of Switzerland and others

These regulatory bodies make sure that brokers do not mislead their clients and explain risks associated with investing. ESMA, FCA of UK, BaFin, and CSSF of Luxembourg are stricter than CySEC and FSC Bulgaria.

Strict regulators make the trading experience much more enjoyable and increase the level of safety. For instance, the strict regulators mentioned above demand from brokers to instantly process your withdrawal requests, fully disclose investment risks, trading fees, and have low leverage. ESMA and other regulators make sure that brokers put the needs of their clients in the center of their business model. Let’s take a closer look and find out why these regulations are so important.

Segregation of traders’ funds

When traders deposit money to their trading balance, the money needs to go somewhere. Low trust and unregulated brokers mix clients’ funds with their own company’s money. In the case of bankruptcy, traders lose access to their own funds.

By implementing segregation of traders’ funds, regulators make sure that even if the company goes out of business, investors receive their money back.

Negative balance protection

Investing in physical assets and investing in CFDs are very different from one another. Investors that prefer stock and precious metals’ ownership will never go negative as they buy and sell assets using their own money.

Short and medium term investors that trade Forex, metals, energies, shares as CFDs and other assets use borrowed money from their brokers to increase their purchasing power. As a result, if a position is too large and the market moves sharply against their position, traders can lose more money than what they had. Having a negative balance means that traders have to pay the money back to the broker and cover the total losses.

Well regulated brokers use negative balance protection to avoid such scenarios. The main tool is automatic stop out levels. Each broker has its own automatic stop out target. Which simply means that orders automatically get closed once they reach certain margin levels to prevent balance from going negative. And even if the unlikely event happens and balance goes negative, brokers that implement balance protection will cover the losses below 0.

Sensible leverage

Strict regulators, such as the Financial Conduct Authority of the UK, demand from brokers to offer clients leverage between 30:1 and 2:1. Leverage is a double-edged sword. It can increase your account balance sharply or cause a momentary decline. 30:1 leverage simply means that for every Euro you deposit, you will get 30 times more purchasing power.

The number one reason why novice investors blow up their accounts is that they fail to manage their risks. The lack of discipline and greed urges them to use high leverage or overtrade.

These rules are in place to protect investors from making uninformed decisions and make brokers to be fully transparent and carrying towards their clients.