It appears that major changes are in store for the U.S. Forex industry. The recent CFTC proposal to limit margin to 10:1 has led to speculation as to what will happen with the U.S. Forex brokerage industry. The latest rumors are that several of these brokers may establish themselves as banks and not fall under the jurisdiction of the CFTC. While this may provide exemption from the proposed leverage reduction, these brokers would now be subject to federal banking regulations. This could prove to be very challenging since Congress is looking to implement laws in a financial regulatory bill which would oversee the banks, the products they trade and how they make money.
Forex traders have already begun to seek out non-US brokers that do not limit their ability to trade. While many traders appreciate the security of dealing with a regulated broker, most do not like to be told how they can trade. The first instance of this occurred in the US when the NFA banned trader’s ability to hold both a long and short position on the same currency pair simultaneously. Commonly referred to as “hedging”, the NFA determined that allowing this type of trade was not in the best interest of retail traders and that the broker benefited by making extra “commissions” entering an opposite trade. What the NFA falied to recognize is that many traders use automated trading systems that employ this type of trading to limit exposure and capture incremental gains. This is akin to entering a “long straddle” in the options universe where a trader buys calls and puts on the same underlying instrument with the goal of profiting when a significant move occurs by closing the losing side and allowing the winning side to out gain the losses of the other trade.
The most recent CFTC proposal concerning leverage has the potential to all but eliminate competition in the US Forex industry as only the large 3 or 4 firms have multiple registrations around the globe that will allow them to operate in other jurisdictions. From a client’s perspective, a mandatory reduction in leverage will be much more restrictive than the FIFO (non-hedging) rule as clients will be required to deposit 10 times additional capital in order to maintain their same level and/or style of trading. This in turn will drive U.S. clients offshore, significantly reducing revenues of the remaining 8-10 U.S. brokers resulting in further consolidation that had 30+ participants just three years ago. How is reducing competition and forcing U.S. clients to open accounts outside the U.S. a positive for the U.S. Forex industry?
One thing that has been overlooked in the past has been the standardization of pricing and execution. In the past, traders have always focused on the location of the broker and the respective regulatory body. It is now more important than ever for traders to be using a DMA (Direct Market Access) provider. Brokers that offer such pricing and execution help to alleviate many of the concerns in the Forex industry. If more and more brokers can move to a DMA standard and use a system like Currenex they may find they won”t be always be at odds with those that write the rules.