January 16, 2010

A ‘London loophole’ for FX

Filed under: Uncategorized — ktetaichinh @ 5:11 am
Tags: , ,

Posted by Izabella Kaminska on Jan 15 11:20.

The CFTC has had a busy week. On Thursday the regulator unveiled details of how it plans to curb excessive speculation in the energy market.

Earlier on Wednesday, meanwhile, it revealed proposals for the spot FX market — an area that has until now escaped the scrutiny of regulators due to its over-the-counter status.

According to the FT, the so-called spot-FX regulatory loophole was cemented in 2004 when a US appeals court ruled that the agency lacked jurisdiction in foreign exchange spot trading.

In the last few years, however, this has caused the market — estimated to be worth some $3,700bn-a-day global, according to Aite — to be the target of many unscrupulous and unregistered operators.

In the first instance, the proposals set out by the CFTC would require registration of off-exchange FX operators as well as disclosure, record-keeping, financial reporting, minimum capital and other operational standards — because believe it or not, no such compulsory requirements exist. It should be noted that more reputable operators do provide these details voluntarily.

The Hedge Fund Law blog has rather decently provided a link to the whole proposal here, but it’s worth pointing out the following snippets (our emphasis):

Subject to certain exceptions (e.g., for certain regulated financial intermediaries not under the Commission’s jurisdiction as established in the CRA), the Proposal would require persons offering to be or acting as counterparties to retail forex transactions but not primarily or substantially engaged in the exchange traded futures business, to register as retail foreign exchange dealers (“RFEDs”) with the CFTC. Registered futures commission merchants (“FCMs”) that are “primarily or substantially” (as defined in the Proposal) engaged in the activities set forth in the Act’s definition of an FCM would be permitted to engage in retail forex transactions without also registering as RFEDs.

The Proposal would further require certain entities other than RFEDs and FCMs that intermediate retail forex transactions to register with the Commission as introducing brokers (“IBs”), commodity trading advisors (“CTAs”), commodity pool operators (“CPOs”), or associated persons (“APs”) of such entities, as appropriate, and to be subject to the Act and regulations applicable to that registrant category. In addition, the Proposal would require any IB that introduces retail forex transactions to an RFED or FCM to be guaranteed by that RFED or FCM.

The Proposal would also implement the $20 million minimum net capital standard established in the CRA for registering as an RFED or offering retail forex transactions as an FCM; propose an additional volume-based minimum capital threshold calculated on the amount an FCM or RFED owes as counterparty to retail forex transactions; and require RFEDs or FCMs engaging in retail forex transactions to collect security deposits in a minimum amount in order to prudentially limit the leverage available to their retail customers on such transactions at 10 to 1.

So in short, the proposals aim to establish a minimum capital base for all retail FX operators and restrict leverage provided to clients to 10:1 (which is a big curb considering it was common for some operators to provide as much 200:1 on a regular basis).

Commenting on the proposals Euromoney’s Lee Oliver noted:

Perhaps the most important new proposal is that FCMs and RFEDs will be required to maintain net capital of $20m plus 5% of the amount by which liabilities to retail FX customers exceed $10m. The CFTC is also suggesting that retail clients will be limited to 10% margins.

Retails service providers have 60 days to respond to the proposals.

Nine players – FXCM, GFT, Oanda, IBFX, Gain Capital, FX Solutions, FXDD, PFG Best, and CMS Forex – have forged the Foreign Exchange Dealers Coalition (FXDC) to manage the industry’s response.

Unsurprisingly their view is the proposals would damage the US FX industry, and do so by forcing it further afield into markets like the UK. As the coalition’s statement read (H/T Lee Oliver):

…the CFTC’s recent rule proposal, which would limit customer trading leverage to 10 to 1, would be a crippling blow to the industry and drive it offshore into the hands of foreign competitors. Even worse, it would encourage fraud both at home and abroad as customers seeking to trade retail forex would have no other legitimate domestic alternative.

As for the immediate effect of the leverage clampdown, they wrote:

• Today the U.S. retail forex industry can boast hundreds of thousands of live accounts. Should the 10 to 1 leverage rule be adopted 90% of those accounts can be expected to go offshore. And the first place they’ll go is to the United Kingdom where customers can trade with leverage as high as 200 to 1.

• The 10 to 1 leverage rule will be highly unpopular with traders. The fact is 100 to leverage is very popular with the retail forex trading public. They simply will not accept 10 to 1 leverage.

• Unregulated dealers from around the world will also be the beneficiaries of the 10 to 1 leverage rule. These unregulated forex dealers don’t have to worry about capital requirements, risk management models, marketing ethics, dealing practices or even returning a customer’s funds. These dealers will be out of the reach of the CFTC and they will thrive.

And while the CFTC’s motivations may have been linked to a wish to clampdown on fraud, the dealers suggest the rules might end up having the very opposite effect:

• The problem of Forex fraud will get worse absent legitimate dealers offering retail forex. Retail forex fraud is not something that is caused by the actions of retail forex dealers; rather it is caused by unlicensed con-men who masquerade as forex experts promising silly and unjustifiable returns before disappearing with customer funds. That is why the FXDC fully su


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