CFTC Reduces Forex Leverage to 50 to 1 (Amongst Other Things!)

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At long last the CFTC have revealed what changes they have in store for US retail forex traders. Their new regulations will come into effect on October 18th, and according to CFTC chairman Gary Gensler they:

Will help protect the American public in the largest area of retail fraud that the CFTC oversees: retail foreign exchange. All CFTC registrants involved in soliciting and selling retail forex contracts to consumers will now have to comply with rules to protect the investing public.

In the CFTC factsheet about the new rules they highlight the following:

  • Maximum leverage of 50 to 1 for majors, and 20 to 1 for other currencies (It's left to the NFA to decide what counts as a "major" currency, and the NFA is also free to impose further reductions in leverage)
  • Forex Introducing Brokers are required to register with the NFA, and either to meet the minimum net capital requirements applicable to futures and commodity options IBs, or to enter into a guarantee agreement with an FCM or an RFED
  • Forex Brokers are required to disclose on a quarterly basis the percentage of "non-discretionary retail accounts" that are profitable, and to keep and make available records of that calculation. Initially brokers will need to provide this information for the preceeding year.

In an additional Questions and Answers document the CFTC elaborate on the following points:

  • Retail customers include individuals and companies with less than $10 million in total assets, or commodity pools with less than $5 million in total assets
  • Brokers that deal primarily in off exchange forex will need to become registered as RFEDs instead of FCMs, and insurance companies, investment bank holding companies and foreign "financial institutions" will no longer be permitted to act as counterparties to off-exchange retail forex transactions
  • For the first time, entities that intermediate retail forex transactions will be required to register with the CFTC, as introducing brokers (IBs), commodity trading advisors (CTAs), commodity pool operators (CPOs) or associated persons (APs) of such entities.

There is also a large amount of small print in the full set of rules, that the CFTC doesn't explain further. As a UK citizen, the first thing that strikes me is that there is still no requirement for segregated accounts. According to the CFTC:

Several commenters [on the original proposals] maintained that the Commission should require segregation of customer funds by counterparties in order to provide some protection in the event of a counterparty insolvency. The Commission’s segregation requirements with regard to futures… require that customer property for trading commodity contracts be kept apart, or segregated, from the FCM’s own funds. However… a segregated funds regime cannot be replicated in the context of off-exchange retail forex trading. Unlike segregation of customer funds deposited for futures trading, under the relevant provisions of the Bankruptcy Code such amounts held in connection with retail forex trading would not receive any preferential treatment to unsecured creditors in bankruptcy.

If you're a US citizen and your broker goes down the tubes it seems as though they will still be able to take your hard earned cash with them!

The CFTC also disagrees with commenters who think that "hedging" should be allowed:

The Commission continues to believe that maintaining open long and short positions in a retail forex customer’s account removes the opportunity for the customer to profit on the transaction, increases the fees paid by the customer, and invites abuse. Nothing submitted by any commenter has demonstrated otherwise.

More risk disclosures are going to be required too. Along with the disclosure of the percentage of profitable accounts a long statement will have to be distributed to all retail forex customers. Here are a few selected extracts:

(1) TRADING IS NOT ON A REGULATED MARKET OR EXCHANGE—YOUR DEALER IS YOUR TRADING PARTNER WHICH IS A DIRECT CONFLICT OF INTEREST. BEFORE YOU ENGAGE IN ANY RETAIL FOREIGN EXCHANGE TRADING, YOU SHOULD CONFIRM THE REGISTRATION STATUS OF YOUR COUNTERPARTY.

(2) AN ELECTRONIC TRADING PLATFORM FOR RETAIL FOREIGN CURRENCY TRANSACTIONS IS NOT
AN EXCHANGE. IT IS AN ELECTRONIC CONNECTION FOR ACCESSING YOUR DEALER. THE TERMS OF AVAILABILITY OF SUCH A PLATFORM ARE GOVERNED ONLY BY YOUR CONTRACT WITH YOUR
DEALER.

(3) YOUR DEPOSITS WITH THE DEALER HAVE NO REGULATORY PROTECTIONS.

(4) YOU ARE LIMITED TO YOUR DEALER TO OFFSET OR LIQUIDATE ANY TRADING POSITIONS SINCE THE
TRANSACTIONS ARE NOT MADE ON AN EXCHANGE OR MARKET, AND YOUR DEALER MAY SET ITS OWN PRICES.

(5) PAID SOLICITORS MAY HAVE UNDISCLOSED CONFLICTS

FINALLY, YOU SHOULD THOROUGHLY INVESTIGATE ANY STATEMENTS BY ANY DEALERS OR SALES REPRESENTATIVES WHICH MINIMIZE THE IMPORTANCE OF, OR CONTRADICT, ANY OF THE TERMS
OF THIS RISK DISCLOSURE. SUCH STATEMENTS MAY INDICATE POTENTIAL SALES FRAUD.

If you currently have a forex account then hopefully you're already aware of all that. If not you may wish to read section 5.5 of the new regulations carefully, since the current required risk disclosures don't go into that much detail!

One final snippet of small print is that requotes will in future be required to be "symmetrical", by which the CFTC means that:

When re-quoting prices, forex counterparties are obligated to do so in a symmetrical fashion, so that the re-quoted prices do not represent an increase in the spread from the initially quoted prices, regardless of the direction the market moves.

There's a whole lot more where that came from too. 44 pages worth of small print from the CFTC, and not forgetting some of the 848 pages of the Dodd-Frank Act that are relevant to retail forex too. At the end of the day US forex brokers are going to have to update their procedures, their paperwork and their trading platforms in a big hurry. Some of them might well decide it's not worth the bother. Even more Introducing Brokers will throw in the towel too. The new registration and net capital requirements go far beyond what is currently required of IBs.

And what of the poor beleaguered US retail forex trader. You might find your current broker disappears and your account is closed or moved to a larger broker. You are even more likely to find your IB disappears, along with any rebate they currently offer you. You might decide that you've finally had enough and try to open a segregated forex account offshore, except that from October 18th non US financial institutions are no longer allowed to act as retail forex counterparties. You might even decide to open a segregated futures account and start trading currency futures instead of off-exchange forex, which is perhaps what the regulators are hoping will happen?

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October 16, 2010

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