The Retail Forex Spot

The National Futures Association (NFA) sent a notice to its Forex Dealers Members (FDMs) reminding them that it’s proposed amendments to FDM financial requirements are set to go into effect on October 31st. The amendments, expected to be approved by the CFTC prior to their effective date, enforce the first stage in the capital requirement increases passed by Congress last spring as part of the CFTC Reauthorization Act of 2008. The amendments will require FDMs to maintain a minimum net capital of $10 million. This is the first of three requirement increases set to culminate in a $20 million requirement in the spring of 2009. Forex Dealer Members who intend to continue operating past the deadline must submit estimated net capital computations to the NFA by 10am on October 31st.

The amendment also includes a revision to NFA financial requirements Section 12(b). Section 12(b) called for increased capital requirements of 200% of the base requirement for FDMs that take advantage of the security deposit exemption allowing clients to hold less than 1% margin on open positions. Under the amended requirements, firms who fall under the security deposit exemption will only be required to maintain 150% of the base requirement.

The latter revision does alleviate some of the unnecessary regulatory overhead on firms who utilize the exemption. Nevertheless the requirement does not take into account the amount of leverage used by the respective firms. Thus, the requirement still places undue burden on smaller firms while potentially exposing larger firms to excessive risk. As of late, several Forex dealers have commented on the need for a formula based rule properly addressing the risks of lower margin requirements.

The Commodities Futures Trading Commission (CFTC) has approved the NFA’s proposed Rules 2-41 and 2-42. The two new rules, set to go into effect on November 30th, require all NFA members who act as Commodity Trading Advisors (CTAs or Money Managers) or Commodity Pool Operators (CPOs or Fund Managers) trading FX to provide proper disclosure documents to their perspective clients. All disclosure documents must be filed with the NFA prior to use. Rules 2-41 and 2-42 are a first step in the NFA’s attempts to create Forex specific rules for CTAs and CPOs after Congress passed the CFTC Reauthorization Act of 2008, requiring all Money Managers and Fund Managers trading FX on behalf of clients to register with the CFTC.

The NFA has also provided text required for inclusion in the disclosures. The disclaimer promptly cautions clients that FX is not traded on an exchange and thus may be subject to greater risks than exchange traded products. Such distinction of FX as a non-exchange traded product has become common practice for the NFA as of late. It is true that exchange traded accounts are given greater bankruptcy protection than over-the-counter (OTC) traded accounts under U.S. bankruptcy law. Nevertheless the fact that the NFA has spent considerable effort pointing out the difference and no effort lobbying congress and the CFTC to address the issue, reminds one of the Futures industry’s considerable influence with the NFA. In fact just this past year the NFA has asked several Forex Dealer Members to disclaim that Forex is not traded on an exchange. The NFA claimed that the words “Foreign Exchange” may mislead potential clients into thinking that retail FX contracts are in fact exchange traded. This is of course a ludicrous claim given that the Bank of International Settlement (BIS) estimates exchange traded FX to make up only 3% of the total Forex market. If anything it is Futures firms that should be required to disclaim that their FX products are in fact non-OTC.

The NFA, an allegedly pro-competition, self-regulatory industry association has been anything but. Though it is only fair to point out that the NFA has been handed a rather difficult task in regulating the often unruly retail Forex industry, its approach has been far from fair and balanced. The NFA has time and again refused to work with the more reputable elements of the industry or grant them rule making participation in this allegedly self-regulatory organization. This has led to a significant portion of the NFA’s FX regulation being rather senseless, as it has been drafted by people with often little knowledge of the operations of the retail Forex industry. This has exacerbated the growing pains experienced by any regulator when faced with the prospect of overseeing a new industry. Over the last few years the NFA has been forced to repeal its own rules and rulings on several occasions simply because it had not taken the time to seriously consider Forex Dealer Members’ suggestions during the first iteration. As one might imagine this approach has not earned the respect and cooperation of the industry’s players and has further exacerbated the problem.