Dec. 21 could be a day of reckoning for forex brokerages. That’s the day new requirements passed by the National Futures Association (NFA) will go into effect, mandating every Forex Dealer Member (FDM) that is a member of the NFA have at least $5 million in capital. Firms offering more than 50:1 leverage will be required to have at least $10 million. Many forex firms are below that capital threshold, but what happens to them on Dec. 21 is still unclear. Many say they will have the necessary capital by that time, others are likely to be purchased by larger firms, and a few will probably go out of business.
Still, the new standards are something NFA CEO Dan Roth thinks are necessary.
“Improved customer protection is our main concern,” Roth says. “There is much greater risk involved in being an off-exchange forex dealer than acting as an agent in exchange-traded futures.”
Roth is not sure if the new regulations will affect the current number of forex firms, but that’s not the main concern. “We are most concerned with the business practices of these firms,” he says, adding that he would like to see the minimum capital requirement eventually raised to $20 million. “We want to make sure all firms are properly capitalized and meet their regulatory obligations.”
The proposal has strong support from larger forex firms.
“We support the new $5 million minimum net capital requirement, as it helps to ensure that all FDMs are better capitalized,” says Glenn Stevens, CEO of GAIN Capital. “In fact, we support the recommendation of a $20 million minimum capital requirement. At the rate retail investors are coming into the markets and with the volatility we’ve seen lately, it’s critical that FDMs are on solid financial footing.”
Stevens says GAIN has already assumed the customer accounts from some smaller FDMs that would have been unable to meet the new requirements, and is in discussions with others.
“The forex industry in the long term will benefit from having a smaller number of better-capitalized brokers,” says Drew Niv, CEO of FXCM. “In essence, a broker with more firm capital is less likely to make imprudent decisions that would put its funds and its customer funds at risk.
“Although these new regulations are good for the industry, the resulting short-term changes may be difficult for clients whose brokers do not meet the new requirements,” Niv adds. “We hope the NFAwill make every effort to facilitate an orderly transition as brokers make new arrangements to enable their clients to trade through firms that meet the new requirements.”
Besides capitalization, the NFA is also stressing a better understanding of how forex dealers do business.
Many brokerages have trading desks and as such are “trading against” the customer, which is not in the customer’s best interest. The entire process is still somewhat confusing to traders, and Roth believes there needs to be more disclosure on the part of the brokerage.
“We’re concerned customers don’t fully understand the relationship they have with the dealer and the potential conflict that exists,” Roth says.
The NFA wants all forex brokerages to fully disclose to customers their position in the trade, and if that position may be profitable to the dealer if it is deleterious to the customer.
“There is no inherent conflict of interest or degradation in price-execution quality in a dealing desk model,” Stevens says. “However, some retail firms have clearly taken advantage of their customers to boost their own profits. Customers quickly caught on, and that spurred non-dealing desk firms.”
Stevens says the important thing to retail traders is that their trade is executed quickly and at the price they requested, and that the difference between a retail dealing desk and a bank-dealing desk are unimportant to the trader if everything else goes as planned.
Gary Tilkin, president and CEO of Global Forex Trading (GFT), supports the changes but takes exception to the belief brokerages don’t always act in the customer’s best interest.
“Many firms that own and operate their own software and are true forex dealers (as opposed to simple brokers who shift the trades to someone else) have to take those customer orders into their own book, at least temporarily,” he says. “This is often done to facilitate very quick executions of orders. As these counter positions build up, the dealer often seeks to offset the risk of these positions with various banks.
“Depending on the size of the forex dealer’s capital, the dealer may or may not offset certain levels of these counter positions. To assume, however, that the dealer is then ‘working against’ the customers with whom they hold no offset positions is totally ridiculous.”
The NFA Board of Directors will soon vote on the proposal; if passed, it will be submitted to the Commodity Futures Trading Commission (CFTC) for final approval.
The CFTC keeps tabs on the account balances of all registered futures commission merchants and updates the information on a monthly basis at http://www.cftc.gov/marketreports/financialdataforfcms/index.htm.
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