Well before the Dodd-Frank Wall Street Reform and Consumer Protection Act became law in July, financial industry officials turned their attention and concerns toward the aftermath – the months of regulatory rulemaking that would define how the act’s many provisions would ultimately be enforced. This process added a layer of unpredictability on top of the legislative outcome. But if the first implementation of a Dodd-Frank mandate, by the Commodity Futures Trading Commission, is any indication, then industry lawyers and lobbyists might have reason to anticipate flexibility and restraint on the part of the regulators.
CFTC showed its Dodd-Frank hand for the first time in a final rule on retail over-the-counter foreign exchange transactions, published August 30 in the Federal Register and taking effect October 18. It was not the biggest forex industry news of that last quiet week before Labor Day in the U.S.
Overshadowing it was the Bank for International Settlements’ preliminary findings from its triennial survey of the global foreign exchange market, showing that daily turnover had reached $4 trillion as of April, 20 percent higher than in April 2007.
The supercharged international FX market is fueled less by retail transactions than by institutional spot trading, including that of rapid-trading hedge funds, pension funds and others that have embraced currencies as an asset class, and even algorithmic techniques that have migrated from other instruments.
But retail investors’ currency momentum has been accelerating in recent years, aided by banks and brokerages catering to these accounts. And, CFTC chairman Gary Gensler pointed out, foreign exchange is “the largest area of retail fraud that the CFTC oversees.”
As CFTC noted in its August 30 press release and a supporting fact sheet on the final rule , the Dodd-Frank Act in tandem with the Food, Conservation and Energy Act of 2008 conferred broad authority on the agency to register and regulate entities serving as retail forex counterparties and intermediaries. The registration requirements cover futures commission merchants (FCMs) and a new category designated as retail foreign exchange dealers (RFEDs). And there is a first-time, $20 million minimum net capital requirement for applicable FCMs and RFEDs.
“Persons who solicit orders, exercise discretionary trading authority or operate pools with respect to retail forex” will also have to register with it, CFTC said, in their roles as introducing brokers, commodity trading advisers, commodity pool operators or as entities associated with those activities.
Where the CFTC backed off of a tighter restriction, as embodied in its initial retail FX proposal, was in permitted leverage, or the use of borrowed funds for trading. The commission previously wanted FCMs and RFEDs to collect a security deposit of 10 percent of the notional value of the transaction.
This so-called 10-to-1 leverage proposal got considerable pushback among the 9,000-plus comment letters submitted to the CFTC. Noting that some complaints from individual traders were part of an organized campaign, the CFTC said in its Federal Register filing that “the most common objections were that the leverage proposal would drive business off-shore, would lead to the loss of jobs in the U.S., was unnecessarily restrictive and would inhibit small traders’ ability to trade profitably, or that the percentage required as a security deposit was arbitrary, capricious and anti-competitive.”
CFTC flatly dismissed those last adjectives.
Industry Give-and-Take
In place of the original 10-to-1 idea, the revised rule, Regulation 5.9, imposes constraints that did not previously exist but are designed to be “anchored in, and adaptable to, market conditions,” CFTC explained.
“The commission has provided minimum security deposit amounts of 2 percent of the notional value for major currency pairs and 5 percent of the notional value for all other retail forex transactions,” the agency said. In other words, the leverage ranges from 20- to 50-to-1.
“The commission will periodically review the parameters it has set in light of market conditions and adjust them as necessary,” it continued. “Similarly, each registered futures association [that is, the self-regulatory National Futures Association] will be required to designate which currencies are ‘major currencies’ and must review, no less frequently than annually,” those designations and security deposit requirements in light of currency volatility and other market factors.
The Foreign Exchange Dealers Coalition , which describes itself as an alliance of the largest U.S. forex dealers, actively opposed the 10-to-1 ratio, calling it “a boon to foreign forex dealers (both regulated and unregulated), who will grow entirely at the expense of retail forex dealers in the United States. Thousands of high-paying jobs will be lost . . . Consumers will be hurt and more vulnerable to fraud. And the United States will toss away one of the most promising export industries that it has.”
Interbank FX, a Salt Lake City, Utah-based trading platform operator, issued a statement endorsing the CFTC action for “providing an enhanced regulatory environment that will help protect retail forex investors and will also create a level playing field for all rules and regulations within the United States.” On the leverage controversy, Interbank FX said, “We believe the CFTC has reached a reasonable compromise with the Forex Dealers Coalition regarding leverage requirements, making 50-to-1 leverage available to all U.S. customers. This compromise on leverage, as opposed to 10-to-1 in the proposed rules, allows the United States forex community to remain competitive with global opponents.”
Eyeing its pivotal role in the process, the National Futures Association has said it will hold a workshop on the new registration and compliance requirements September 25 in conjunction with the Money Show’s Futures and Forex Expo in Las Vegas.
Jeffrey Kutler is editor-in-chief of Risk Professional magazine , published by the Global Association of Risk Professionals.
