The Retail Forex Spot

Request for Comments on Forex Proposals

Recent NFA examinations and investigations have uncovered a number of Forex Dealer Member (”FDM”) practices that disadvantage or confuse customers. NFA trading platform reviews have also highlighted weaknesses in these systems. NFA has drafted several proposals to address these concerns and is seeking comments on them from FDMs. These proposals pertain to a range of FDM activities including treatment of customer orders, customer confirmations and statements, the disclosure of rollover/interest charges, the exercise of discretionary trading authority over customer accounts, and independent testing of electronic trading systems.

Customer Orders

Requoting

Requoting is a legitimate practice when it is objective and evenhanded. When NFA staff visited FDMs that requote customer prices, however, it found that some would only requote prices if the new price favored the FDM. The practice of requoting only when it benefits the FDM is detrimental and unfair to customers. Accordingly, NFA is proposing that where an FDM requotes customers prices it must do so regardless of the direction in which the market has moved, and an FDM may not execute a customer order at a price worse than that reflected on the platform at the time the order is executed.

Limit Orders

In on‑exchange trading, if the market moves through a limit price the order is filled at the better of the market price or the limit price. In contrast, some FDMs fill customer orders at the limit price even when the prevailing market price is better. NFA is proposing that an FDM must execute an executable limit order at the limit price or the prevailing market price, whichever is better. This is in harmony with the rules regarding limit orders for on‑exchange transactions.

Offsetting Forex Transactions

During recent examinations, NFA discovered that some FDMs offer a trading strategy that they refer to as “hedging,” where customers take long and short positions in the same currency pair in the same account. NFA is concerned that customers employing this strategy do not understand either the lack of economic benefit or the financial costs involved.

This strategy essentially eliminates any opportunity to profit on the transaction and increases the customer’s financial costs in several ways. One way it increases costs is by doubling the expense of entering and exiting the transactions. A forex customer will pay the entire spread twice (buying at the high end of the spread and selling at the low end) rather than paying half on entry and half on exit. Additionally, the customer pays carrying charges that always exceed the funds it receives.

In a normal transaction, a customer receives “interest” on the long position and pays “interest” on the short position. Since the two transactions are mirror images, you would expect the receipts and payments to zero out, but the amount a customer receives on a long position is always less than the amount a customer pays on a short position.

Since these transfers occur daily when the positions roll over, the loss increases continually over time. Since this strategy provides no economic benefit to customers and, in fact, produces built-in losses through the spread and the carrying charges, NFA is proposing to prohibit it.

Customer Statements

NFA rules already provide general guidance on what confirmation and monthly statements to customers should contain. Unfortunately, FDM confirmations and monthly statements lack uniformity and are hard to follow, and in some instances are missing information that is essential for understanding the transactions and the status of the account.

Customer statements pertaining to on-exchange futures transactions are subject to more detailed CFTC requirements and have greater consistency and clarity. Therefore, NFA is proposing to adopt a new rule that spells out the information that must be included in FDM confirmations and monthly statements. NFA modeled the new rule on CFTC Regulation 1.33, which governs on-exchange transactions, although there are several significant differences.

First, in addition to the transactions that require a confirmation under Regulation 1.33, the proposed rule requires confirmations for rollovers and any adjustments to an account. Second, Regulation 1.33 requires monthly statements to show all options transactions during the month even if the position is closed by the end of the month, but this information is not required for futures contracts. We believe that the same information should be provided for both forex options and non-options contracts, so the proposed rule requires the monthly statement to show all transactions (i.e., initiating and offsetting) as well as all open positions. Third, Regulation 1.33 requires monthly statements to show how much an open option is in-the-money, if it is. NFA believes that unsophisticated customers should also understand how much their open options positions are out-of-the-money (and, therefore, how likely they are to result in losses).

Finally, some FDMs point customers to the cash balance in the account when those customers ask how much the account is worth. Since the cash balance does not include unrealized profits and losses, it presents a distorted and misleading picture of account value. Therefore, NFA proposes requiring FDMs to provide daily statements that show the account equity as of the previous day and to prominently display the account equity on daily statements, confirmations, and monthly statements.

Disclosure of Rollover/Interest Charges

FDMs use different methods of charging customers for rollovers, but the most common is to collect “interest” on short positions that exceed the “interest” paid on long positions. Some FDMs merely pass on the charges or payments they receive from their liquidity provider, but others add a mark-up or mark-down. This amount may vary from day to day. Although FDMs must already disclose all costs, fees, and charges incurred by the customer (including rollover charges), NFA is concerned that customers do not understand how FDMs calculate rollover charges and payments and how they affect the customer’s bottom line. Therefore, NFA is proposing that FDMs disclose how they calculate rollover charges and payments, including the name of any sources they use in doing so.

Discretionary Trading Authority

FDMs have an inherent conflict of interest when they exercise discretionary trading authority over customer accounts for which the FDM acts as counterparty. If the FDM does not automatically offset its positions with customers, it makes more money when the customer loses money. Even if an FDM does automatically offset its positions, it still has an incentive to overtrade the account to create more profit for itself. Accordingly, NFA is proposing that FDMs be prohibited from exercising trading authority over customer accounts for which they act as counterparty.

Independent System Testing

How trading platforms operate is crucial to the integrity of customer trades, so NFA is proposing changes to the periodic testing and review requirements to ensure that annual reviews of these platforms are conducted by independent outside parties and that all relevant functions are covered in the review.

For your convenience, attached are the draft rules and amendments implementing the above referenced proposals. NFA would appreciate your input on these proposals. Comments should be in writing and must be received by November 4, 2008. The comments should reference “Forex Rule Proposals” and be sent to:

National Futures Association

300 S. Riverside Plaza, Suite 1800

Chicago, Illinois 60606

E-mail: forex@nfa.futures.org

Fax: (312) 559-3363

If you have questions about these proposals, contact Edward Dasso, Director, Compliance (edasso@nfa.futures.org or 312-781-1551) or Lauren Brinati, Senior Manager, Compliance (lbrinati@nfa.futures.org or 312-781-1215).