How to tell a forex broker from a market maker

Following up on How to tell if a broker is regulated, here’s the answer to another classic: is my forex “broker” really a broker, or a dealing desk?

NB: if you’re unsure why brokers and dealers (market makers) tick differently, watch this webinar. All we do here is get the regulator to tell you what’s what, in language meant for traders, not lawyers. Our goal is to explain stuff clearly, but if you think any of the below is incorrect or misleading, comment below & accept our apologies!



(To learn how to reach the FCA’s financial services register, follow these instructions before you read on.)

A (minimal!) primer on European MiFID regulation

Broadly speaking, European MiFID regulation involves 3 dimensions when it comes to trading:

  1. Activities: certain financial activities fall within the regulated perimeter – i.e. to carry them out, persons have to 1) apply for regulatory permission and 2) agree to abide by the regulations. These include, amongst others, whom you employ (are they fit and proper?), how you advertise, how much regulatory capital you must hold, your internal processes, etc.
  2. Instruments: not all financial instruments are equally risky – thus the regulator verifies on what instruments the regulated person is fit to carry out the regulated activity
  3. Customer type: not all customers are equally vulnerable to financial abuse. Goldman Sachs can reasonably be expected to know the risks in trading with leverage, in a way that e.g. your average 93 year old pensioner cannot.

Because one of the goals of regulation is protect vulnerable economic agents from unfair treatment – the demands on agents offering trading of high risk instruments are proportionately higher.

Broker activities & permissions

The minimum set of regulated activities – and therefore, MiFID permissions – involved in legally operating a European brokerage are (hyperlinks to the FCA glossary) :

  1. Agreeing to carry on a regulated activity –
  2. Making arrangements with a view to transactions in investments
  3. Arranging (bringing about) deals in investments
  4. Arranging safeguarding and administration of assets
  5. Dealing in investments as agent
  6. Dealing in investments as principal

Given you’re looking for a broker, did you spot the odd permission out?

Spot the odd man out

Brokers dealing as Principals???

A broker ought to be an agent – not a principal – to customer trades! Surely anyone dealing in investments as Principal can’t be a broker?

Right! Why, then, does someone like Darwinex claim to be a broker, but carry permission to deal as principal?

Because spot foreign exchange or contracts for difference, or spread-bets are traded over the counter. OTC instruments are not available from any of the Exchanges recognised by the FCA, so there’s NO organised market for an agent to source them for you. To get around this, every European broker (even agency-only ones) offering OTC instruments needs permission to “Deal in investments as principal”.

So, every European forex / CFD / spreadbetting broker could be trading against me?

NO! Some remain agency only by limiting their dealing in investments as principal permission with a “matched-principal” restriction (click on the image below to visit Darwinex’s regulatory profile) as per below.

Excerpt from our permissions

This imposes on Brokers the “matched-principal” trade flow:

  1. Customer goes LONG 1 Lot EURUSD…
  2. Broker goes SHORT 1 Lot EURUSD (using the “Dealing in Investments as Principal” permission)…
  3. At the same time, matched-principal brokers go LONG 1 Lot EURUSD against independent liquidity providers – aka “the market”.

Note that all a dealer could do to internalise the customer P&L (internalise = fancy word to say that dealers win when customers lose, and viceversa) is NOT enter the matched-principal, market facing trade leg. With a matched-principal broker, after the third “with-customer” trade leg:

  1. The customer is LONG the EURUSD.
  2. The market is SHORT the EURUSD against the customer, via the broker
  3. The matched-principal-broker is trading with the customer, against the market. At heart, he remains an agent despite acting as a principal on the customer leg. This is the only way to source OTC investments on a pure agency basis in Europe

As a relevant side-note, notice the nuance on incentives:

  1. First order, the broker doesn’t care how the EURUSD moves, as his P&L is the net offset of 2 other principals (customer and market). This is the reason why pure brokers trade market risk for counterparty risk – and if you want to understand the implications watch this.)
  2. Second order, brokers prefer winning customers – they trade bigger volumes, for longer than losing customers, which means more commission

That’s it: to tell a dealer from a broker, all it takes is ask the FCA.

No matched-principal restriction? It’s a dealing-desk / market maker / dealer. By the way, the FCA requires 5 times more regulatory base capital from dealers than for matched principal brokers. If told by a “broker” that they carry the dealing permission just in case, you know the next question to ask 🙂

4 replies
  1. John S.
    John S. says:

    Nice post. However, from a client’s perspective, it doesn’t matter whether the broker will take the other side of a client’s trade or “match” it through the market. The only issue is if the broker is then going to manipulate its bid/ask prices, which is a different problem. We recently saw a broker that apparently matched orders through the market but actually ended up trading with a market counterparty that was an undisclosed affiliate. Regulators should look at price manipulation, full stop. A-book, B-book, it’s secondary.

    • The Market Owl
      The Market Owl says:

      Thanks for your reply John! The example you have just put forward -pure broker manipulating prices- is a fraud and we fully agree that regulators should make sure this does not happen again. Having said that, if you are trading with a market maker you’ll never know if the bid/ask is manupulated since your order never goes to the market and they can requote the price ad infinutum. We are not saying that market makers are bad per se since we believe that some of them are pretty legit but, from a client’s perspective (some of us in Dariwnex are also traders) it is important that incentives are fully aligned. That is why we are, and will be, a pure broker. Have a great day!


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