From the October 01, 2010 issue of Futures Magazine • Subscribe!

CFTC’s new rules for forex

Splitting the difference

The Commodity Futures Trading Commission (CFTC) issued new rules regarding the forex markets on Aug. 30 -- limiting available leverage to 50-1 -- the first new rules to come out of the Dodd-Frank Wall Street Reform and Consumer Protection Act that was passed early this year.

The CFTC Reauthorization Act of 2008 cleared up questions about the CFTC’s jurisdiction over forex. Dodd-Frank requires all entities offering retail forex to be regulated and for each regulator to establish rules. The CFTC, because they had already proposed rules, were required to finalize rules 90 days after the passage of Dodd-Frank.

The most significant sections of the new rules concern leverage, registration and recordkeeping. The CFTC proposed limiting forex leverage to 10-1 in January from the recently set 100-1, but settled on 50-1 in its final rule. The commission received a record number of comment letters on the proposal, mostly negative.

Technically, the new rules leave the question of leverage up to the National Futures Association (NFA) but sets a parameter of a 2% security deposit requirement for major pairs and 5% for others. Prior to rules implemented in 2009, traders could access leverage as high as 400-1.

In addition to reducing the amount of leverage retail traders can use, the CFTC, based on Dodd-Frank, will make it more difficult for traders to access non-U.S. dealers. According to a CFTC document, “the Dodd-Frank Act specifically provides that among financial institutions, only United States financial institutions are permitted to act as counterparties [for retail forex trading].”

“It is hard for either the firm or the regulator to interpose themselves and decide what is best for the customer, how the customer should bear risk, what the customer’s risk appetite is and how carefully they can regulate their own financial exposure,” Joseph Trevisani, chief market analyst at FX Solutions, says. “The CFTC clearly sees itself as wiser and is making these choices for the customer.”

Japan also increased requirements in July setting leverage at 50-1, saying it will move to 25-1 in two years.

In addition to new leverage requirements, the rules set requirements for who has to register with the CFTC. Any entities that wish to serve as counterparties in forex trading will have to register as either a futures commission merchant (FCM) or a retail foreign exchange dealer (RFED). Additionally, any other 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.

“It is forcing more participants in the market to get registered, which is a good thing because there have been scams in the past and this is aimed at reducing those scams,” Kathy Lien, director of currency research at GFT, says.

Finally, new recordkeeping rules will require brokers to report on a quarterly basis the percentage of accounts under their management that were profitable. This will allow traders to not only see how profitable the market is in general, but also may point traders to those brokers from which they can get the best bid-ask spreads.

The new rules are scheduled to take effect on Oct. 18.

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