By James Bibbings -- On Jan. 13, the Commodity Futures Trading Commission issued a press release regarding its highly anticipated rule proposal for the regulation of retail forex transactions. The proposal seeks to adopt a new regulatory scheme to implement the CFTC Reauthorization Act of 2008. In particular it strives to address the way the federal agency will deal with off-exchange transactions in foreign currency with the retail public. Currently, the CFTC’s proposal is open for public comment for 60 days and was published in the Federal Register on Jan. 7. Before anyone can comment though, they’ll have to fully understand what the proposal says.
What the Proposal Attempts to Establish
The following is a summary listing of the major provisions included in the CFTC’s proposal. While reading through these items please note that they are not the only changes to the law which have been proposed. Rather, these items represent what will be the most significant changes to the industry through the eyes of a former regulator and industry professional; they are presented in order of most important to least.
1) The CFTC has revised its definition of “commodity interest” (i.e. futures) to include off-exchange retail forex transactions (“forex”). This change grants the CFTC jurisdiction over the United States retail forex market.
2) With the authority found in item one above; the CFTC will create new registration categories for retail foreign currency firms as follows:
A) Dealers (Currently FDM’s) in retail forex transactions will be required to register as retail foreign exchange dealers or (“RFEDs”).
B) Persons or entities that solicit or accept orders for an RFED, a Futures Clearing Merchant (“FCM”), or an affiliate of an FCM will be required to register as Introducing Brokers (“IBs”).
C) Persons or entities exercising discretionary authority over accounts will be required to register as Commodity Trading Advisors (“CTAs”).
D) Persons or entities which operate or solicit funds or property for a pooled investment vehicle would be required to register as Commodity Pool Operators (“CPOs”).
E) All persons who qualify as being “associated” with the foregoing registration categories will be required to become registered as associated persons (“AP’s).
3) All Introducing Brokers (“IBs”) and all applicants working towards registration as IBs in connection with retail forex transactions will be required to enter into a guarantee agreement with an RFED.
4) RFEDs and FCMs which engage in retail forex transactions will be required to collect from their customers a security deposit equal to no less than ten percent of the notional value of the retail forex transaction to be conducted; thus imposing a strict 10:1 leverage ratio.
Items 1 and 2: Revised Definition of “Commodity Interest”: The definitional change of “Commodity interest” to include off-exchange retail forex transactions gives full authority of the US retail foreign currency market to the CFTC. Based on this definitional adjustment the CFTC will now have the legal ability to require forex professionals to register with the agency. It also means these professionals will be required to become members of a self regulatory organization (“SRO”) which in most instances will be the National Futures Association (“NFA”). Firms will be required to register by law as RFEDs, FCMs, IBs, CTAs, and/or CPOs to solicit for or accept retail customer orders. Many of these firm’s employees will then also be required to become APs and/or business principals.
Item 3: All IB’s Must Be Guaranteed by an RFED: This provision of the proposal is likely to be more devastating to the United States forex industry than any other. The reason? Requiring RFED’s to be entirely liable for the solicitation activity and performance of all their introducing brokers will prove to be impossible. Since there will be no such thing as an independent forex IB, it does not seem reasonable to think that the handful of RFEDs in the United States will be willing to take on the risk of guaranteeing all of the nation’s introducing agents. If they were to do so, the level of liability as well as the capital required to stand behind the performance of such entities would be staggering. Further this requirement completely eliminates the role of an independent IB as it calls for each guaranteed IB to introduce client accounts to only its guarantor RFED. This will greatly reduce consumer and IB strategy options and may also cause clients to open relationships with multiple brokerage houses. For these two reasons, and the requirement discussed below in item 4, third party forex brokerage as it currently exists will be under tremendous stress.
Item 4: Forex Transactions Must Adhere to 10:1 leverage: There has been more written about this portion of the CFTC proposal than any other and perhaps rightfully so. Currently in the US firms are able to offer clients 100:1 leverage, which is already lower than what is available in other parts of the world. At this time US customers appear to be satisfied with security deposit levels which currently reside at either 1% or 4% (by pair traded) of a contracts notional value. Although the CFTC may believe that lowering leverage from 100:1 may be better for clients (which in many cases it will be) I do not believe they have fully considered the ramifications of this action.
It is largely anticipated that in the event leverage in the US is reduced from 100:1 to 10:1 most US accounts will migrate to the United Kingdom. Individual traders have voiced publically that they are unwilling to post higher levels of margin to trade within the United States. Specifically many have shared that as long as well regulated, financially similar, trading venues exist internationally; staying in the US will not make sense with a 10% security deposit. Therefore, if the objective of the CFTC is to protect US investors with their new proposal and this occurs, they may actually be making matters worse. If US clients are encouraged to move their accounts abroad on to pursue higher leverage, the CFTC will then no longer have jurisdiction over the companies handling those accounts and the point will become moot.
In addition to potentially losing jurisdiction over US client monies, should a capital exodus occur on the count of reduced leverage, the CFTC will have also made US RFED’s less competitive internationally. The implications here are far reaching; especially when one considers the size of the global forex market space. Furthermore, reducing leverage by as much as ten times will also drastically reduce off exchange retail currency trading volumes for RFEDs. If this were to occur these firms would likely seek out new forms of revenue in order to supplement falling profit margins. They would likely do so through various fees and/or by additional commissions through wider trading spreads. This too will not be good for the US retail trader or the RFED’s which directly and indirectly create numerous employment opportunities. Worst yet, it is conceivable that an adjustment to the security deposit, especially when coupled with the requirement to guarantee IB’s, might move some RFEDs entirely out of the country.
Options and the Long Road Ahead
Share Your Thoughts: Now that the CFTC proposal exists, what’s next for retail forex traders and brokerage firms within the United States? The first thing that should be done if you’d like to comment on this proposal would be to submit your thoughts to the CFTC and your legislators. The CFTC will accept comments for at least 60 days starting from January 7.
When sending in a comment it will be important to use the subject “Proposed CFTC Regulation of Retail Forex”; Federal Register - January 7th, 2010. After this be sure to include the proposals identification number which is RIN3038-AC61 in the body of your message.
To comment on the proposal choose one of the following options:
Emailing: email@example.com or using the CFTC’s online form
Fax comments to (202) 418-5521, or mail to:
Secretary, Commodity Futures Trading Commission
21st Street, NW
Washington DC 20581
Industry Professionals: Industry professionals that have not yet registered with the CFTC and elected to become NFA members; now is the time. It is possible that the CFTC may alter some of its proposed amendments if it deems the comments received from the public are reasonable. However, it is highly unlikely that the requirement for all forex professionals to become CFTC registrants and members of a DSRO will be omitted. In just a short period of time every forex firm in the country will be required to register and this will create a massive back log with the NFA. To learn more about this process it would be advisable to contact a regulatory professional and seek advice immediately. Due to the time sensitive nature of this requirement it would also be wise to look for a company that is well versed in forex compliance. Most importantly they should be intimately aware of the CFTC’s current proposal.
Retail Traders: Individuals who trade retail forex will need to consider the implications of having to post as much as ten times more capital to hold trades open. This will materially alter trading strategies and significantly reduce the size of the positions that a person can initiate. Customers should speak with their respective brokerage houses, the CFTC, NFA, and their legislators to let them know how this rule will impact their trading.
James Bibbings is the President and CEO of Turnkey Trading Partners (“TTP”), a firm that supports all commodity and forex specific regulatory and business needs. Prior to founding TTP, Bibbings worked with the National Futures Association (“NFA”) as a supervising auditor. During his time with NFA he was involved in over 100 investigative audits and was able to gain a deep working knowledge of FDM, FCM, IB, CTA, and CPO operations. Bibbings has provided financial markets content for MSN, Yahoo, FinAlternatives, Wiki-Investments, Safe Haven, Financial Sense, Market Watch, FX Street, Commodity News Center and many other highly acclaimed investment publications. He has also authored two highly sought after informational pamphlets regarding futures and forex registration which are available for free upon request through his company website. If you have any questions or comments for Bibbings he can be reached directly by email at firstname.lastname@example.org and would love to hear from you.