Risk never sleeps: A preview of risk and fraud concerns for 2017

Chris Lee

Risk never sleeps, a time honored bit of wisdom that suggests that we never take our eye off the fraud ball, so to speak. Risk also comes in many different disguises, whether it is systemic, affecting nearly every participant in the industry, or specific, causing an individual to suffer a loss that he was unprepared to accept. Fraud is merely one aspect of that latter variety, but, as we found out in 2016, bad business practices can amount to the same thing, although not necessarily a criminal offense. What is the forecast for 2017? Many current themes will persist and expand, while new entrants wreak havoc.

The last few years have not been kind to our industry. Forex brokers and traders alike have been buffeted by crisis after crisis. If one wave did not take you down, then there was always another waiting in the wings to ruin your day. As a result, many brokers suffered insurmountable losses, having to shut their doors, be acquired, or scramble to find new equity investors. Traders were not immune either. Even though casualty rates are high in foreign exchange trading due to the higher risks involved, many veterans were also caught flatfooted, as margin calls went through the roof across the globe.

In case you have forgotten the past “lessons” of history, here is just a brief recap of the constant barrage of bad tidings that were inflicted upon us all:

2012 and Before: Let’s at least draw a line in the sand at this point, subsequent to the Great Recession. Our industry and others had to deal with the flurry of new legislation that was designed to protect the consumer and ensure that our friendly “banksters” did not create another disastrous recession of their own making. Dodd-Frank was but one act of many in several jurisdictions. This particular set of rules revised capital and reporting requirements and set new limits for leverage within the United States. Many brokers were forced to sell their programs and depart the scene, never to return.

2013: Cyprus, a small island community in the middle of the Mediterranean, had been a success story of how a small member of the EU could prosper as a financial center for the region. Countless financial service companies had set up shop on the island, including nearly one hundred forex related brokerages. A banking crisis, however, took the island by storm. The two largest banks in Cyprus had over indulged in Greek sovereign debt, which brought both banks to their knees when the debt was massively devalued. The second bank folded. The first was taken over by the state, and deposits were frozen. Subsequent “haircuts” on large depositors, primarily mainland brokerage houses without offshore presences, drove many firms into bankruptcy.

2014: Retail forex trading was definitely in flux after the crisis in Cyprus erupted, having already adapted to a host of new regulations that were transforming the industry. To make matters worse, it came to light that six of the largest financial institutions on the planet had been rigging “foreign exchange prices of U.S. dollars and euros from Dec. 2007 to Jan. 2013.” Over $6 billion in fines were eventually assessed against these banks for the acknowledged wrongdoings on the part of traders in their backrooms. It would become know as the largest scandal ever to rock the foreign exchange industry. Regulators in every major jurisdiction were embarrassed to learn that their auditors had been asleep at the wheel.

2015: The effects of the financial crisis in Europe have lingered on for years. Despite the best intentions of Mario Draghi and the ECB, the European economy has refused to mount a sustainable growth dynamic, ignite inflation, or materially reduce the overall levels of unemployment, especially in the weaker EU member states. To make matters worse, the Swiss Central Bank decided abruptly and without forewarning to remove the “peg” between the Euro and the Swiss Franc. The market reaction was traumatic. The Euro fell as much as 40% in some quarters. Losses were gigantic for traders, brokers, and hedge funds. Due to their risk- limiting nature, binary option firms were unharmed by the severe moves in the market, but billions in dollars were lost in an instant across the globe. FXCM lost $700 million and sought emergency capital to stay alive. The Everest Capital Global Fund blew out $830 million and closed shop. Customer accounts went negative, and brokers that had been teetering on the edge became bankrupt before their very eyes. Systemic risk is nearly impossible to predict or hedge against, another cruel lesson that had to be absorbed by the industry.

2016: This year will go down as the year of the regulator. Embarrassed by the enormity of the foreign exchange rate-fixing scandal in major bank trading rooms, regulators the world over suddenly came to life and went on the warpath, by, as we wrote, “coming down hard on anything that smells like an infraction in the forex industry.” Their aggressive moves actually began to take shape in 2015, when the FCA first raided the high profile offices of CWM FX and then shut down the operations of Plus500 over AML/KYC compliance defalcations. Contracts for Difference (CFDs) also seemed to be a target on the radar screen, but investigative journalism soon uncovered the unseemly side of the binary options industry. Aggressive marketing tactics across national borders were creating enormous consumer losses, especially in the EU, where binary options had free rein. Regulators were caught flatfooted, once again. As a yearend surprise, the FCA and CySEC announced new rules to curb what they perceived as industry shortcomings. Brokers and traders were caught unaware and are in disarray.

What are the prospects for 2017 and what are the risk hurdles to be aware of?

How many more body blows can our industry take before unraveling? Unfortunately, as long as casualty rates remain high (some 65% for traditional forex trading and into the nineties for CFDs and Binary Options), then government officials will continue to press for more protections for the consumer. Scam artists will also step up their efforts, while confusion reigns in the marketplace.

As we polish off our crystal balls and look forward to the year to come, there are several circumstances that will guide the prevalence of risk and fraud in our industry. The seven topics below will give you a frame of reference for what to expect and prepare for. Risk preparedness and fraud prevention begin with awareness. Take heed of these fundamental drivers for the ensuing twelve months.

#1 – Industry revenues are contracting with uncertainty looming.

The Bank for International Settlements (BIS) just completed their Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity. The bad news is that the BIS found that “total turnover in foreign exchange markets dipped from $5.4 trillion per day in the 2013 survey to $5.1 trillion per day in 2016.” Speculation is down, which means that revenues have been contracting. Previous published results from brokers have been mixed, but the fact is that the pressure is on in the industry. When Donald Trump assumes office, there may be other issues that impact international trade, as well. There will still be opportunities, but risk profiles just got greater.

#2 – The Binary Option industry is under attack for shady business practices.

Regulators have adamantly attempted to stamp out cross-border solicitations by unauthorized companies that have aggressively pursued their citizens and scammed them out of their savings. It was not until the Times of Israel published an exposé in March that everyone began to connect the dots. Simona Weinglass, an investigative reporter for the paper, determined that, “Fraudulent binary options is a vast criminal enterprise, employing thousands of people in over 100 companies, many of them in Israel, but also in countries like Romania, Bulgaria, Ukraine and the Philippines.” The losses in the EU alone are in the billions of dollars. Israeli authorities are cracking down.

#3 – Current fraud trends will continue: Ponzi, Clones, and all manner of scams.

If the old hits work, then the old hits will keep coming, modified a bit to adapt to newer technologies. It is amazing how often Ponzi schemes appear in the news, especially now in developing markets of the world. As for newer threats, Clone websites have grabbed the headlines of late. The FCA is particularly perturbed by these look-alikes that seek to deprive you of your funds by appearing to be legitimate companies. Social media has also become a playground for scammers. Keep your personal ID information secure.

#4 – Cyber criminals will gain more momentum in all markets.

Protect you private ID information. Do not respond to tempting links that will connect you with criminal servers in the hopes of installing mal-robots on your Internet device. These robots will report back keystroke info related to login and password data, which will be monetized at some unfortunate later date in the future.

#5 – Regulatory broadsides will reshape industry dynamics.

The FCA and CySEC surprised everyone during December by announcing new rules to limit leverage and increase transparency in the forex industry for CFDs and spot forex under certain circumstances. When the FCA acquires responsibility for binary options, you can expect another shoe to drop. Brokers are in turmoil.

#6 – Moves to convert forex to regulated exchanges will gain more support.

The Interbank foreign exchange market is primarily an informal marketplace, but the pressure is on from regulators to create national exchanges, much like stock exchanges, in order to force better business practices. Flexibility, execution speeds, and cost demographics will suffer as a consequence, if it comes to pass.

#7 – Industry consolidation will be commonplace.

Declining revenue, tougher regulations, intense competition, and an enraged public spell trouble with a capital “T” for brokers and ultimately for traders. Mergers and acquisitions are now commonplace, as many entities hang on for their dear lives. It would be wise to monitor your current broker’s performance. If it smells like trouble, consider making a change midstream.

Concluding Remarks

2017 will certainly be a year chock full of surprises, as well as a period where current trends will continue to be omnipresent in our industry. Risk never sleeps, not does organized crime in its pursuit of your hard-earned cash. Preparedness and prevention begin with awareness. Take the above insights to heart in preparing your personal defenses. Be wary of unwarranted solicitations of any kind from any source. Continually monitor your broker’s performance and prepare to switch if things become dicey. Uncertainty will be ubiquitous in the year ahead, but stay skeptical and persevere.

Happy New Year!

Chris Lee

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