Proposed leverage crackdown provokes forex dealers

After years of legal and legislative wrangling, the Commodity Futures Trading Commission (CFTC) took steps in January to enforce its jurisdiction over the U.S. retail foreign exchange market.

In a Jan. 13 proposal, the CFTC sought to assert its regulatory authority over the cash, or spot, currency market by cracking down on leverage, requiring forex brokers to register with the Commission, and boosting capital requirements for brokerage firms. The goal is to protect traders from fraud and large losses, but a group of retail forex brokers is fighting back by claiming the proposal, specifically the attempt to limit leverage to 10-1, will drive currency traders to less-scrupulous dealers overseas.
 
Who regulates forex?
Unlike the stock and commodities markets, the forex market had fallen through regulatory cracks. Congress tackled this issue in the Commodity Futures Modernization Act of 2000, but the legislation failed to give the CFTC authority over the spot currency market, and a 2004 appeal further weakened the Commission’s oversight.

However, the landscape changed two years ago when Congress finally gave the agency power over retail forex brokers in the Farm Bill, or the CFTC Reauthorization Act of 2008. With its January proposal, the Commission was simply applying this new authority.

The CFTC acted because it has “observed a number of improper practices that have raised concern … solicitation fraud, lack of transparency in the pricing and execution of transactions, unresponsiveness to customer complaints, and the targeting of unsophisticated, elderly, low net worth individuals,” the proposal said.

Regulators have uncovered dozens of fraud cases and Ponzi-scheme activities involving forex since the global financial markets tanked in 2008. Perhaps the most notorious case appeared in November 2009, when the Securities and Exchange Commission (SEC) charged Trevor G. Cook and Patrick Kiley, an ex-radio host who touted his trading services on the air, with defrauding more than 1,000 customers out of $190 million. The pair allegedly used the money, in part, to support a lavish lifestyle that included seven cars, a house boat, and a submarine, according to a Jan. 25 SEC news release.

The leverage debate
Few dispute the need to police the forex market or the CFTC’s right to impose new guidelines, but its significant reduction of leverage to 10-1 from up to 100-1 has alarmed some retail currency traders and their brokerage firms.

Within days, a group of nine U.S. forex dealers — FXCM, Gain Capital, IBFX, FX Solutions, FXDD, CMS Forex, PFG Best, GFT, and Oanda — slammed the proposal. Such a drastic reduction in leverage “would be a crippling blow to the industry and drive it offshore into the hands of foreign competitors,” the group stated in a letter published online. Unlike in the U.S., foreign brokerage firms now typically offer leverage of up to 200-1.

Dennis Holden, deputy director of external affairs at the CFTC, declined to comment on the proposal. 

The proposed cap on leverage comes two months after the National Futures Association (NFA), a self-regulatory arm of the futures industry, agreed to limit leverage in the major spot currency pairs — i.e., Euro/U.S. dollar (EUR/USD) and British pound/U.S. dollar (GBP/USD) — to 100-1, or 10 times larger than the Commission may ultimately allow.

For example, under NFA rules, which the CFTC accepted on Nov. 30, 2009, U.S. currency traders could trade a $100,000 position with only $1,000 in capital as opposed to $10,000 required under the CFTC’s latest proposal. And in late January, one could trade currency futures such as the CME Group’s eurocurrency contract (EC) with leverage of about 30-1.

For the Commission to change its stance on forex leverage “without even giving us a reason … has sent shockwaves through the industry to say the least,” says Charlie Delano, director of government affairs at FXCM.

Making it official
Although the CFTC’s proposed leverage reduction has raised eyebrows, the suggested changes focus on registering brokerage firms and their employees — including introducing brokers (IBs), commodity trading advisors (CTAs), and commodity pool operators (CPOs) — with the agency.

Forex firms will be required to register as futures clearing merchants (FCMs) or retail foreign exchange dealers (RFEDs), a new label cited in the 2008 Farm Bill. Moreover, all forex firms must hold at least $20 million in net capital plus five percent of customer liabilities beyond $10 million, the proposal states. The public comment period on the proposal ends March 22. To comment, send an e-mail to secretary@cftc.gov with “Regulation of Retail Forex” in the subject line and “RIN 3038-AC6” in the message.


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