There is a rumour doing the rounds that there may be a little more than meets the eye to the new CFTC proposals to reduce leverage for retail forex traders from 100:1 to 10:1.
The rumour involves a turf war. The two rival gangs are futures brokers and forex brokers. The futures brokers are the Old Boys Club, the forex brokers are the cocky new kids on the block. Both are registered at the NFA, both are regulated by the CFTC, but at the moment there is only one winner - the forex brokers.
Forex brokers' growth skyrocketed while futures commission merchants at best stagnated. It is estimated that 20% of forex trading in Japan is now done by people like you and me, little people, who were previously excluded from this game. A major New York based forex broker claims 150,000 live trading accounts and $600 million in client funds.
So the Old Boys Club, the futures brokers in Chicago, watched as new forex start-ups grabbed more and more of their market share every day. The forex guys so effectively combined new technology (the internet) with aggressive marketing that they leapfrogged the competition puffing on their cigars in dark wood-panelled rooms.
Some Futures brokers incorporated forex brokers and added forex to the mix of their offer to the public. But it wasn't enough. While some of these measures helped to stop the drain of their existing client base they were stagnating in terms of growth while forex brokers were booming.
So what did they do? Here's my educated guess. Let's look at the history.
Initially the Futures Modernization Act (that regulated both futures and forex traders) had the best interest of the forex trader and investor at heart because it brought some much needed regulation into a gangster paradise. Except it didn't stop there.
In fact they went on regulating and regulating and regulating. In fact, the CFTC took more regulatory actions against a handful of forex brokers in a few years than they took against all the rogue old boys in their many years of not always proud and ethical existence! And still the regulatory screws tightened.
All these regulations about global spot forex trading were legislated in the US Farm Bill of 2008 and the powers so vested in the CFTC. Farm Bill? That's right, pork bellies, bushels of corn, and forex - to the regulator it was one and the same. Find that a bit strange? I do.
Take a quick look at this:
• The 2002 Act asked for measly capital requirements of $250,000 for forex brokers.
• Soon this was increased to $1,000,000, then $5,000,000. Swimming in cash most of the forex brokers posted this collateral out of their back pockets and more were registering every month.
• Regulations soon set the minimum at $20,000,000.
Another attack by the regulator, furiously lobbied by Chicago, was on forex brokers' marketing practices:
• Content - marketing code violation. Text was misleading, promises reckless (many were, let's be fair)
• Then came the introducing brokers (who send business to forex brokers) - I suddenly found myself being told to adjust the content of my website notwithstanding this website not having any reference to NFA regulated forex brokers.
• Then came the attack on the whole introducing broker business model. It was simply too efficient. Barriers to entry were non-existent, new markets were totally undeveloped. The introducing broker model grew the forex broker's business like crazy. And so US forex brokers were prohibited from paying compensation to introducing brokers introducing US clients to them.
• Even that wasn't enough. US-based introducing brokers then had to become members of the NFA and post some collateral with the NFA.
Then the coup de grace:
• FX Brokers had to mark client accounts to market in real time. Not even in bank dealing rooms do they mark to market in real time. But you and I suddenly had to be marked-to-market on a second-by-second basis.
• FX Brokers were no longer allowed per ticket execution, all orders had to be executed on a FIFO basis (first in first out).
• That affected hedging also. No hedging, no exceptions. No lobbying to change this, just a month or two to implement the necessary technological changes to systems.
• And finally these latest 10:1 leverage proposals - this is futures leverage levels.
Picture emerging? The 2009 regulations caused many US fx brokers to set up offices offshore and to move US clients offshore. Still the regulator came after them. For example, my company, Dayforex will not be compensated by a very well known broker in London for introducing US customers to this non-US registered company (their offices in London)!
Who is benefiting from this? The broker? You? Me? I don't think so. But I do think a few frowns in dark wood-panelled Chicago boardrooms have turned to smiles once more.
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