The regulation that has dropped on the industry like a bomb is NFA Compliance Rule 2-43. Although 2-43 addresses many issues, the two most important are Anti-Hedging and FIFO.
Anti-Hedging Anti-hedging has been the most controversial new regulation. It has, in many ways, turned the retail FOREX business on its head—at least for the moment. Traders are prohibited from entering and brokers are prohibited from accepting orders that would place a trader on both sides (buy and sell) of any currency pair. Traders use speculative hedging for a wide
range of trading and money management functions, including the popular news trading technique and multiple time-frame systems.
FIFO (First In First Out) Related to anti-hedging, FIFO changes the manner in which open orders are ledgered and closed. Orders entered first must be closed first. Again, this substantially upsets the applecart for many traders, especially those who are short-term traders, those who tier in positions, and those
Price Adjustments Brokers are prohibited from canceling customer orders except under certain conditions. Price adjustments to filled orders may only be made for specific, limited reasons. This part of Rule 2-43, while unpopular with brokers, is generally accepted as positive by traders.
Capital Requirements for Retail FOREX Broker-Dealers Broker-dealers in retail FOREX must meet higher and higher capital requirements. As predicted in the first edition and began in the second edition, mergers are now common in retail FOREX. Small firms, both good ones and bad ones, are getting shut out. who use automated trading systems.
The CFTC Reauthorization Act of 2008 increases the adjusted net capital requirement for certain counterparty FCMs to $20 million. This requirement was phased in; it is a quantum leap from the previous $5 million. A counterparty FCM is generally considered to be a market maker—a broker-dealer who trades as counterparty to their customers. The author predicts the entire counterparty paradigm will be revisited by the CFTC and NFA soon. Introducing Brokers (IB) who coattail on an FCMs capital base are now also required to meet minimal capital requirements of their own.
Recently, a small broker-dealer with good customer support was shut out by this regulation and, as I write, is looking for a new FCM sponsor. I can hear the conversation with a prospective FCM’s CEO: “Sir, we offer our customers terrific customer service. It is the touchstone of our business model.” “Go away, kid.” Regulations often have unintended consequences.
Registration of FOREX Money Managers The NFA has proposed to the
CFTC that every FOREX money manager must register as a Commodity
Trading Advisor (CTA) in the same manner and with the same process as
those who manage money in commodity futures.
It is assumed the CFTC will oblige, but final regulations, at the time of this writing, have not been passed or implemented. Nonetheless, most retail FOREX broker-dealers are now requiring that money managers who work with their customers must go ahead and register as a CTA. It is possible that FOREX money managers who have been in business for a certain number of years might be grandfathered—but no one is counting on this. It is likely that exemptions from registration similar to those for commodity futures CTAs will stand. The most important of those are: (1) your primary business is not that of a CTA and you do not hold yourself out to the public as a CTA, and (2) you manage fewer than 15 accounts.
To provide for the new registration requirements a separate test has been created, the Series 34 examination. FOREX CTAs will be required to pass the Commodity Futures Series 3 examination as a prerequisite. Again, at the time of this writing, final rules have not been released.
As mentioned earlier, many brokers—including the majors—are affiliating with overseas broker-dealers who are not obligated to comply with NFA and CFTC regulations. One broker told me that two of their best money managers will leave if they are required to register as a CTA. File this one also in the unintended consequences folder. As a former CTA I can attest that regulation is an expensive proposition. If you manage $20 million per year, $100,000 to meet all the requirements to sustain an audit is doable. If you manage $2 million, it makes no sense at all.
TIP: This bears some watching because it involves a small loophole through which a few brokers are driving large trucks. One suspects that the CFTC and NFA will become interested soon.
Another area continuing to receive regulatory attention is graciously called a “harmonization issue” by the industry.
Suitability/Know-Your-Customer Requirements This is NFA Compliance Rule 2-30. This basically requires broker-dealers to determine suitability to trade retail FOREX on a customer-by-customer basis, not, as in the old days, with a simple acknowledgment on the account form, “You understand the risk of FOREX trading.” But there is still little specific guidance and enforcement by the NFA. One may expect that to change soon.
Some brokers still allow a customer to deposit and withdraw funds with services such as PayPal and eGold. One strongly suspects Know-Thy-Customer will bring those methods to a close in the not-too-distant future. FOREX brokers now typically do withdrawals in kind: If you made a wire deposit, your withdrawal will be sent by wire.
Margin Requirements In late 2009 the NFA also mandated minimum margin requirements for retail FOREX positions: 1 percent for any pair containing one or both of what the NFA labels as “majors”—USD, GBP, CHF, CAD, JPY, EUR, AUD, NZD, SOK, NOK, DKK. All others now require a 4 percent margin. This means that for U.S. traders the maximum leverage is 100:1 and 25:1, respectively.
Many U.S. broker-dealers have already established overseas offices to stem the tide of customers leaving in droves because of Rule 2-43 and the new margin requirements. Few will want to trade exotic currency pairs at 25:1 leverage.
Foreign Regulation
Many foreign countries also regulate retail FOREX, though typically not at the level of the NFA and CFTC in the United States. The United Kingdom’s Financial Services Authority (FSA) bears the most similarity to the NFA and CFTC.
Regulation Future
Only time will tell if the current pace of regulation will continue, or if it will slow down, allowing participants to digest what they currently have on their plate. But, clearly, the regulatory cat is out of the bag in retail FOREX. Regulation Future bears watching by all players in the retail FOREX space. As we go to press there are rumors that some factions in the CFTC want to force retail FOREX into an exchange environment similar to commodity futures. As mentioned above, the market-making paradigm may be on the chopping block soon. We shall see.
Summary
The FOREX forums are a good place to find updated regulatory information as well as traders’ (and sometimes brokers’) take on them. Both the CFTC web site, (www.cftc.gov) and the NFA web site (www.nfa.futures.org) are worth a peek on a monthly basis. For those who wish to dig deeper, I recommend www.forexlawblog.com. As the Madoff case demonstrates, regulations sometimes miss the forest for the trees; security is truly in your hands and knowledge is still king.
Fraud is always fraud, irrespective of specific industry regulations. I recommend FOREX traders keep copies of everything as well as screenshots of relevant web pages and communication logs.
Anti-Hedging Anti-hedging has been the most controversial new regulation. It has, in many ways, turned the retail FOREX business on its head—at least for the moment. Traders are prohibited from entering and brokers are prohibited from accepting orders that would place a trader on both sides (buy and sell) of any currency pair. Traders use speculative hedging for a wide
range of trading and money management functions, including the popular news trading technique and multiple time-frame systems.
FIFO (First In First Out) Related to anti-hedging, FIFO changes the manner in which open orders are ledgered and closed. Orders entered first must be closed first. Again, this substantially upsets the applecart for many traders, especially those who are short-term traders, those who tier in positions, and those
Price Adjustments Brokers are prohibited from canceling customer orders except under certain conditions. Price adjustments to filled orders may only be made for specific, limited reasons. This part of Rule 2-43, while unpopular with brokers, is generally accepted as positive by traders.
Capital Requirements for Retail FOREX Broker-Dealers Broker-dealers in retail FOREX must meet higher and higher capital requirements. As predicted in the first edition and began in the second edition, mergers are now common in retail FOREX. Small firms, both good ones and bad ones, are getting shut out. who use automated trading systems.
The CFTC Reauthorization Act of 2008 increases the adjusted net capital requirement for certain counterparty FCMs to $20 million. This requirement was phased in; it is a quantum leap from the previous $5 million. A counterparty FCM is generally considered to be a market maker—a broker-dealer who trades as counterparty to their customers. The author predicts the entire counterparty paradigm will be revisited by the CFTC and NFA soon. Introducing Brokers (IB) who coattail on an FCMs capital base are now also required to meet minimal capital requirements of their own.
Recently, a small broker-dealer with good customer support was shut out by this regulation and, as I write, is looking for a new FCM sponsor. I can hear the conversation with a prospective FCM’s CEO: “Sir, we offer our customers terrific customer service. It is the touchstone of our business model.” “Go away, kid.” Regulations often have unintended consequences.
Registration of FOREX Money Managers The NFA has proposed to the
CFTC that every FOREX money manager must register as a Commodity
Trading Advisor (CTA) in the same manner and with the same process as
those who manage money in commodity futures.
It is assumed the CFTC will oblige, but final regulations, at the time of this writing, have not been passed or implemented. Nonetheless, most retail FOREX broker-dealers are now requiring that money managers who work with their customers must go ahead and register as a CTA. It is possible that FOREX money managers who have been in business for a certain number of years might be grandfathered—but no one is counting on this. It is likely that exemptions from registration similar to those for commodity futures CTAs will stand. The most important of those are: (1) your primary business is not that of a CTA and you do not hold yourself out to the public as a CTA, and (2) you manage fewer than 15 accounts.
To provide for the new registration requirements a separate test has been created, the Series 34 examination. FOREX CTAs will be required to pass the Commodity Futures Series 3 examination as a prerequisite. Again, at the time of this writing, final rules have not been released.
As mentioned earlier, many brokers—including the majors—are affiliating with overseas broker-dealers who are not obligated to comply with NFA and CFTC regulations. One broker told me that two of their best money managers will leave if they are required to register as a CTA. File this one also in the unintended consequences folder. As a former CTA I can attest that regulation is an expensive proposition. If you manage $20 million per year, $100,000 to meet all the requirements to sustain an audit is doable. If you manage $2 million, it makes no sense at all.
TIP: This bears some watching because it involves a small loophole through which a few brokers are driving large trucks. One suspects that the CFTC and NFA will become interested soon.
Another area continuing to receive regulatory attention is graciously called a “harmonization issue” by the industry.
Suitability/Know-Your-Customer Requirements This is NFA Compliance Rule 2-30. This basically requires broker-dealers to determine suitability to trade retail FOREX on a customer-by-customer basis, not, as in the old days, with a simple acknowledgment on the account form, “You understand the risk of FOREX trading.” But there is still little specific guidance and enforcement by the NFA. One may expect that to change soon.
Some brokers still allow a customer to deposit and withdraw funds with services such as PayPal and eGold. One strongly suspects Know-Thy-Customer will bring those methods to a close in the not-too-distant future. FOREX brokers now typically do withdrawals in kind: If you made a wire deposit, your withdrawal will be sent by wire.
Margin Requirements In late 2009 the NFA also mandated minimum margin requirements for retail FOREX positions: 1 percent for any pair containing one or both of what the NFA labels as “majors”—USD, GBP, CHF, CAD, JPY, EUR, AUD, NZD, SOK, NOK, DKK. All others now require a 4 percent margin. This means that for U.S. traders the maximum leverage is 100:1 and 25:1, respectively.
Many U.S. broker-dealers have already established overseas offices to stem the tide of customers leaving in droves because of Rule 2-43 and the new margin requirements. Few will want to trade exotic currency pairs at 25:1 leverage.
Foreign Regulation
Many foreign countries also regulate retail FOREX, though typically not at the level of the NFA and CFTC in the United States. The United Kingdom’s Financial Services Authority (FSA) bears the most similarity to the NFA and CFTC.
Regulation Future
Only time will tell if the current pace of regulation will continue, or if it will slow down, allowing participants to digest what they currently have on their plate. But, clearly, the regulatory cat is out of the bag in retail FOREX. Regulation Future bears watching by all players in the retail FOREX space. As we go to press there are rumors that some factions in the CFTC want to force retail FOREX into an exchange environment similar to commodity futures. As mentioned above, the market-making paradigm may be on the chopping block soon. We shall see.
Summary
The FOREX forums are a good place to find updated regulatory information as well as traders’ (and sometimes brokers’) take on them. Both the CFTC web site, (www.cftc.gov) and the NFA web site (www.nfa.futures.org) are worth a peek on a monthly basis. For those who wish to dig deeper, I recommend www.forexlawblog.com. As the Madoff case demonstrates, regulations sometimes miss the forest for the trees; security is truly in your hands and knowledge is still king.
Fraud is always fraud, irrespective of specific industry regulations. I recommend FOREX traders keep copies of everything as well as screenshots of relevant web pages and communication logs.
