At a time when Congress is restructuring our entire regulatory system with a specific goal of harmonizing rules among disparate regulators, the Financial Industry Regulatory Authority (Finra) is proposing a rule that would sharply bifurcate margin levels required in forex between brokers/dealers and everyone else.
On Dec. 1, Finra amended rule 2380 to require broker/dealers — including broker/dealers who are dually registered as future commission merchants (FCM) — to limit the leverage forex customers could use to 4 to 1. That is much lower than the standard allowed in over-the-counter (OTC) foreign exchange or futures — between 25- and 100-1— but much greater than 1.5-1 originally recommended in the rule.
Not to be outdone, the Commodity Futures Trading Commission (CFTC) proposed on Jan. 13 to limit leverage in retail forex customer accounts to 10-1. The proposal was part of a larger regulatory overhaul of retail forex by the CFTC, enabled by authority granted to it in the Food, Conservation and Energy Act of 2008, or the Farm Bill.
The Finra proposal, even after it was softened in December, drew ire from market participants who say it would effectively prohibit broker/dealers from offering OTC foreign currency products.
In its comment letter to the Securities and Exchange Commission (SEC), TD Ameritrade strongly opposed adoption of the rule and noted, “the amended proposal, if enacted, would only serve to harm retail investors as it would effectively eliminate their ability to engage in forex as part of their investment strategy in a securities account or in a separate forex only account with a forex member firm.”
The Futures Industry Association commented, “the rule would simply cause those broker/dealer customers that wish to engage in OTC foreign exchange transactions to interact with other permitted counterparties… such a result is both self-defeating and unsound as a matter of regulatory policy.”
Several comment letters to the previous version of the proposal recommended providing an exemption to dually registered firms who would then come under National Futures Association (NFA) regulations regarding forex. A spokesperson for NFA says they are aware of the possibility of a carve out and are looking at the appropriate rule changes that such an exemption would require them to write. However, Finra amended the rule without including an exemption for dually registered firms.
NFA rules set margin levels of 1% of notional value (100-1) on major currencies and 4% (25-1) on less liquid currency pairs. Futures margins range approximately from 20-1 to 50-1.
MF Global in its comment letter called the rule proposal anticompetitive and said, “Finra should not be imposing leverage limitations on any broker/dealers but certainly not on those dually registered as FCMs.”
In response to the initial wave of comment letters, Finra said the thrust of many of the comment letters “is to advance the pecuniary interests of dually registered BD/FCMs at the expense of investor protection.”
In a follow-up comment, Interactive Brokers noted, “Opposing the rule is not favoring our pecuniary interests over the interests of investors — because investors will be wholly unaffected by the rule and will remain 100% able to engage in forex trading at 40-1 or 50-1 or 100-1 through Citibank, Deutsche Bank, CME, and every U.S. bank or FCM who chooses to offer it. Rather, our comments are inspired by our pecuniary interest versus those of all of these competitors.”
A Finra spokesman noted, “Finra believes that leverage ratios of 50:1, 100:1 or higher are inconsistent with our mandate to protect investors, in particular retail investors. Our submission explains that Finra does not believe that its regulatory program is bound by limits established by other regulators. Different regulators may pursue their regulatory mandates in different ways.”
While there is no denying the wild west reputation of OTC forex trading, it seems odd that if these rule proposals are passed, nearly the only traders who will be allowed to trade forex with extremely high leverage would be the large dealer banks, many of whom where bailed out by the unwashed retail masses.