Hi everyone

I wanted to share with all of you an article I just got from Felix Shipkevich, V.P. & General Counsel at Capital Market Services, LLC, a FX FDM from the U.S.

The article highlights the risks of the new requirements the NFA wishes to implement in the U.S. FX industry in order to better control such teenager industry.

The article does not add much new information about the whole situation but I found it interesting though.

Enjoy it

Francesc

Are regulators creating a monopoly of the Forex industry?
In his recent speech regarding the re-authorization of the Commodity Futures Trading Commission (CFTC), Dan Roth, president of the National Futures Association (NFA), announced a proposal for new rules and regulatory measures to its two dozen Forex Dealer Members (FDMs). The NFA regulates the retail Over-the-Counter Foreign Exchange (Forex) industry under the jurisdiction of the CFTC. The proposal outlines rule changes designed to better protect investors’ funds. However, it will have a drastic effect on the industry as it undermines the ability of some FDMs to continue their business or properly protect their financial exposure. 

The regulators are seeking to ensure that FDMs carry enough capital to cover customer funds. In an attempt to achieve that goal, in the past 2 years alone, the NFA has raised the minimum adjusted net capital (ANC) of the financial requirements to $1 million, then to $5 million effective December 21st, 2007. Without seeing the effects of these newly established thresholds, the proposed requirement is now $20 million. If the new requirements go into effect, it may cause a major overhaul of the Forex industry. FDMs which offer the option of leverage higher than 1:100 would be required to maintain an amount double the ANC. This additional requirement raises the threshold as high as $40 million. This means that an FDM would be required to have $40 million dollars safely stowed away and sitting in a bank account.

The new threshold may force some existing dealers to consolidate and would make it undeniably harder for new and prospective FDMs to form in this relatively new industry, only a decade or so in existence. The industry is already small, with only about two dozen firms operating at this time, and the proposed regulation will make it that much more anti-competitive. At this time, only a handful of the FDMs have the resources to independently withstand such a drastic increase in capital requirements. All but the largest FDMs, are alarmed that adoption of the proposed rules will put them in the position of considering two unappealing possibilities; merging or liquidating. NFA’s proposal would potentially weed out the smaller firms, less capable of holding the necessary capital, and would put hundreds of jobs in jeopardy. At the same time it would reward the larger, more capable companies with a bigger market share, potentially monopolizing the industry.

What the regulators fail to address is that the majority of the actions brought against entities for illegal Forex activities have involved unregistered solicitors. It is these dealers that pose one of the biggest threats to the industry. The industry seems to be helpless in an effort to protect customers’ funds handled by unregistered parties. Limiting the types of firms with which an FDM may do business with should be an efficient, justifiable and reasonable solution. It could include entities that are regulated by the NFA, or other foreign equivalent self-regulatory or government agency of the jurisdiction in which the affiliate is registered.

Forex is not new on the international arena with two thirds of the customers coming from abroad and generating well over $1 billion in customer funds, bringing money into the US even at the time of recession. Foreign jurisdictions such as the UK, Japan and Hong Kong have an established Forex industry, without the same problems faced by the US due to the fraudulent activities brought on by unregistered solicitors. The capital requirements in these jurisdictions allow for the assessment of the particular risks and needs of the firm member. For example, the largest base capital requirement in UK is €730,000 with additional risk-assessment based formulas. Japan’s capital requirements are entirely formula based.

It is understandable that the intent behind raising the ANC is to provide some form of a safety net for existing customers and potential investors. The lack of bankruptcy protection for US customers’ funds in Forex is one of the primary concerns of the regulators and so the proposal is a step in the NFA’s broader effort to fill that gap. The effect however, would go well beyond merely bumping up an already existing regulation to practically wiping out most members of the industry. The new financial requirements as they are proposed with the $20M adjusted net capital requirement, would make the industry anti-competitive and would seem to have the opposite effect of the intent of the regulators by putting Customers’ funds at risk by virtue of greater financial exposure and risk of insolvency for its members.

Felix Shipkevich
V.P. & General Counsel
Capital Market Services, LLC