A few weeks ago, I spoke with several young Ugandans who had lost money to fraudulent forex brokers.
In Uganda, more young people engage in forex trading than invest in traditional capital markets products like shares, bonds, ETFs, or Unit trusts approved by the Capital Markets Authority. This is largely due to the accessibility of Forex trading through the internet and global connectivity.
Unlike the Capital Markets Authority of Kenya, which made regulations for forex dealing and non-dealing brokers, the Capital Markets Authority in Uganda does not have such regulations in place. However, this does not mean that there are no global standards that online forex brokerages should adhere to.
It is important to differentiate between the business of a Forex bureau, which is regulated by the Bank of Uganda, and forex trading. In forex trading, individuals take positions in the market for investment purposes, either through spot contracts or derivatives.
Many Forex brokerages use something called 'A Contract for Difference (CFD),' which allows traders and investors to profit from price fluctuations without actually owning the underlying assets. Forex trading invites the public to take positions in the market. Many online brokerages targeting Ugandans do not have access to the real market and may manipulate price movements in their favour.
They may also manipulate the amount they pay back to clients. Furthermore, most of these brokerages lack a "liquidity provider," a crucial component for successful electronic trading in today's financial markets Fraudulent online forex brokerages often open offshore accounts, set up IT systems, and manipulate the market to benefit themselves.
They also generate demo servers to manipulate prices, and they operate without the backing of a liquidity provider. Recently, a young Ugandan attempted to sue a forex company for non-payment, but the company is an offshore entity with no presence in Uganda, presenting jurisdictional issues for legal proceedings.
Globally, there are 'A-book' brokerage companies and 'B-book' companies in the forex markets. A-book brokers operate in strict regulatory environments, while B-book companies often target countries with less regulatory scrutiny such as Uganda. An A-book broker is a type of broker that, after you place a trade, sends your trades to liquidity providers. Liquidity providers are large institutions such as central banks and inter-banks that offer liquidity to the brokers.
A-Book brokers make money through commissions and spreads. They don't make money through other means like manipulating the markets. They use the ECN/STP broker system, meaning they send your trades to their liquidity providers. ECN brokers only route orders to the interbank market, whereas STP brokers can route orders to any of their liquidity providers such as banks or interbank exchanges.
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This process may take a bit of time, so there might be a slight delay in executing trades, especially with well-integrated brokers. Overall, A-Book Brokers have no conflict of interest. How about the B-Book Brokers? B-Book Broker is a broker that provides the market for your trades and does not rely on external sources for liquidity.
This means they trade against you by taking the opposite side of your trade. At least 95 per cent of B-Book brokers are in the business of making money from traders and encouraging them to trade more, as it increases their earnings. These brokers, also known as market makers or dealing desks, profit when traders lose money. As they are the ones providing the market for your trades without relying on external liquidity, there is a potential conflict of interest and the possibility of market manipulation.
There are online platforms that use both types of brokers, A-Book and B-Book. When you open an account and start trading with them, they deploy algorithms to monitor your trading data and history.
If they notice that you are consistently winning and profitable, they will transfer you from B-Book to A-Book using their well-developed algorithms. Conversely, if you are consistently losing, you will remain on the B-book side and may struggle to make money, as these programs are capable of manipulating the market when you are in a trade.
The writer is a lawyer at Pentagon Advocates
