Category: Financial Regulation

Learn Why The NFA Barred FXCM And What It Means For Forex Traders

February 22, 2017 | By: Robert A. Green, CPA

With the recent news of the National Futures Association (NFA) barring Forex Capital Markets, LLC (FXCM) from membership, many forex traders are scurrying to replace FXCM. It’s imperative that American retail traders understand Commodity Futures Trading Commission (CFTC) regulations for off-exchange forex before making their decision.

If a forex dealer wants to do business with American retail traders on leveraged forex contracts off-exchange, the CFTC requires the forex dealer register with the CFTC, SEC or bank regulator. There is CFTC-registered Retail Foreign Exchange Dealers (RFED), and CFTC-registered Futures Commission Merchant (FCM) Forex Dealer Members. For a listing of these “Forex Firms,” see Directory of CFTC Registrants and NFA Members. There are also SEC-registered broker-dealers, banks, and other regulated financial institutions, as explained in Forex Transactions, A Regulatory Guide (see counterparties on page 2).

In his well-known “Gensler-Letter” in 2009, CFTC Chairman Gary Gensler asked Congress for more authority to regulate the “retail” spot forex marketplace. Chairman Gensler argued that retail spot forex trading platforms were successfully evading CFTC regulation by mislabeling their products as “spot forex” transactions; he thought they were more appropriately “futures-like” and therefore under the CFTC umbrella of control. Here is a press release by the CFTC describing new regulations subsequently promulgated, effective October 2010. At that time, the CFTC created a new class of membership, RFED.

FXCM bombshell news
On Feb. 6, 2017, the NFA barred FXCM from membership due to “numerous deceptive and abusive execution activities that were designed to benefit FXCM, to the detriment of its customers.” The NFA Directory of members listed FXCM as an RFED, FCM, Forex Dealer Member and Forex Firm.

A MarketWatch article, FXCM names interim CEO, changes name to Global Brokerage wrote “The CFTC said FXCM was “engaging in fraudulent activities” with respect to FXCM’s retail customers, by telling them they used a “No Dealing Desk” order execution model, meaning orders would be executed directly in the market without using a liquidity provider, or market maker. But in fact, FXCM used a “Dealing Desk” model, by routing orders through market maker Effex Capital LLC that was actually supported and controlled by FXCM, allegedly in exchange for kickbacks to FXCM on profitable trades.”

There are two remaining CFTC-registered RFED: Gain Capital Group LLC based in the U.S., and Oanda Corporation from Canada. Oanda and Gain Capital are also CFTC-registered FCM Forex Dealer Members. Retail forex traders have other options for CFTC-registered counterparties: There are several CFTC-registered FCM Forex Dealer Members, although they may set higher minimum account sizes vs. RFED.

Dealing desk vs. no-dealing desk execution
A “dealing desk” acts as a counterparty to its forex traders; it offsets some client trades against other client trades, some against the house, and it lays off net risk with participants in the interbank market. Gain Capital and Oanda state they are dealing desks.

A “no-dealing desk” acts as a counterparty for customers, too. It mostly acts as an “agent,” immediately executing client trades with other participants in the interbank market.

Trading offshore
As stated above, the CFTC does not permit foreign or domestic forex brokers or banks to act as a counterparty to American retail off-exchange forex traders unless the forex dealer registers with the CFTC, SEC or U.S. bank regulator. It’s the law from the Commodity Futures Modernization Act (CFMA) of 2000. Some unregistered foreign forex dealers accept American retail clients, and they may become a target of CFTC enforcement.

I recently asked an NFA media relations person about this issue and she replied that “CFTC regulations and NFA rules generally are applicable to the firms engaging in over-the-counter retail forex. These rules and regulations do not apply to individual customers/investors.” (I asked the CFTC if they condone American retail forex traders going offshore with unregistered forex firms. Stay tuned for an update.)

The lesson of FXCM is that even working with a CFTC-registered forex dealer can be risky. Using an unregistered offshore forex dealer may be dangerous if you are trading with significant leverage, don’t have money-protection coverage, the firm is a bucket shop or the CFTC takes enforcement action against the firm.

Other CFTC and NFA rules for off-exchange leveraged forex trading

CFTC caps on leverage: RFED working with American retail traders must cap leverage on the major currency pairs at 50:1, and on the minor currency pairs at 20:1. (See my post: New CFTC Forex Trading Rules Call For 50:1 Leverage.)

Hedging rule: The NFA Rule 2-43b Forex Orders states “Forex Dealer Members may not carry offsetting positions in a customer account but must offset them on a first-in, first-out basis.”

ECPs who meet certain high net worth requirements are “institutional” and exempt from CFTC regulations for American retail off-exchange forex traders. Eligible Commercial Entities (ECE) are free from these rules, too. (For a definition of ECP, click here and for ECE, click here.)

If You Want To Trade Bitcoins, First Learn CFTC Rules

February 16, 2017 | By: Robert A. Green, CPA

The CFTC requires counterparties, including brokers and exchanges, doing business with American retail customers to register if they offer “leveraged” or “financed” financial products, including derivatives. The CFTC brought an enforcement action against unregistered Bitfinex of Hong Kong because they offered leveraged cryptocurrency contracts to American retail customers. Several other unregistered offshore exchanges offer leveraged cryptocurrency contracts to American retail customers. Many Americans trade cryptocurrency on exchanges that do not provide leveraged contracts, and that seems okay.

Bitcoin is the most famous cryptocurrency, and there’s been significant price volatility the past few years. That’s attracted American retail traders to Bitcoin exchanges offering leveraged trading and derivative products based on Bitcoin price movements.

In this post, I discuss CFTC regulation for Bitcoin counterparties (exchanges and brokers), and in my related post, I cover tax treatment for trading Bitcoin. (See If You Traded Bitcoin, You Should Report Capital Gains To The IRS.)

Is Bitcoin trading legal for American retail customers?
Some American retail customers trade leveraged or financed cryptocurrency contracts with counterparties that are not registered with the Commodity Futures Trading Commission (CFTC) or another U.S. regulator to allow cryptocurrency trading by American retail customers. I asked the CFTC and National Futures Association (NFA) if that is legal, and both said CFTC regulations for American retail customers apply to counterparties, not American retail customers. Does that imply that leveraged Bitcoin and cryptocurrency trading may be legal for American retail customers, and illegal for counterparties? Perhaps, yes, but I am not sure. It’s risky for American retail customers to trade leveraged Bitcoin contracts or another leveraged cryptocurrency because the CFTC may take enforcement action against their counterparties as it did against Bitfinex (see below). Maintain control of Bitcoin wallets to avoid some counterparty risk with regulators.

CFTC regulations
The Commodity Futures Trading Commission (CFTC) requires counterparties, including brokers and exchanges, to register with the CFTC if they offer leveraged or margined financial products to American retail traders. That includes some Bitcoin exchanges and Bitcoin derivative products.

If a forex dealer wants to do business with American retail traders on leveraged forex contracts off-exchange, the CFTC requires the forex dealer register with the CFTC, SEC or bank regulator. There is CFTC-registered Retail Foreign Exchange Dealers (RFED), and CFTC-registered Futures Commission Merchant (FCM) Forex Dealer Members.

The CFTC considers Bitcoin a “currency,” but not a “foreign currency.” The CFTC says Bitcoin is not forex, so it doesn’t fall under the forex regulations. The CFTC also refers to Bitcoin as a “commodity.”

The North American Derivatives Exchange, Inc. (Nadex), a U.S.-based CFTC-regulated exchange, offered leveraged Bitcoin binary contracts until it discontinued that product at the end of 2016. On Dec. 16, 2016, Nadex filed a Self-Certification to Delist Bitcoin.

Bitcoin exchanges offering leverage try to escape CFTC jurisdiction
Bitcoin exchanges have sought exemption from CFTC jurisdiction in claiming traders are “making and taking delivery” of each trade on their “exchange,” by transferring the title into Bitcoin wallets. The CFTC does not regulate private transactions in commodities, or forward contracts when made for delivery within 28 days. For example, a farmer may sell wheat to a cereal manufacturer for immediate delivery, or with a forward contract. A warehouse receipt is evidence of delivery.

CFTC jurisdiction applies to counterparties offering futures, options, derivatives, and financed (or leveraged) retail transactions for future delivery. In the CFTC enforcement case cited below, the CFTC explained how leveraged trades in the spot Bitcoin market with an American retail customer fell under CFTC jurisdiction as a financed retail transaction. The CFTC also disagreed that Bitfinex made full delivery of Bitcoin to traders.

Two CFTC enforcement cases against Bitcoin exchanges
Bitfinex in June 2016, and Coinflip in September 2015. Read CFTC vs. BFXNA INC. d/b/a BITFINEX and CFTC Bitfinex Enforcement Action, an analysis by law firm Clifford Chance. Here are some excerpts from the Clifford Chance client briefing:

  • “The Order expands the CFTC’s regulation of bitcoin and other cryptocurrencies into spot markets under certain conditions.”
  • “The result is that spot trades qualifying as financed retail transactions will be regulated as if they were futures trades.”
  • “The Exception does not apply since the bitcoins were not actually delivered. In finding lack of actual delivery, the CFTC looked to the fact that at all times Bitfinex held the private keys needed to access the wallet where bitcoins were held.”

On-exchange vs. off-exchange
On-exchange means a CFTC-registered U.S. futures, options or derivatives exchange like the CME, CBOE, ICE, NYMEX and NADEX.

On-exchange also includes foreign futures and options exchanges, providing the CFTC issued a “Part 30 Letter” granting the foreign exchange permission to solicit accounts with American retail customers. The exchange must demonstrate similar rules as in the U.S. including posting prices, setting margin requirements, meeting capital adequacy, and more. (See a list of CFTC Part 30 Letters on the CFTC website.)

The CFTC’s mission is to protect American retail customers
The CFTC prefers leveraged trading transactions for American retail traders conducted on-exchange, so the exchange may act as the counterparty to both buyer and seller, who otherwise do not know each other. With off-exchange forex, the CFTC-registered RFED and Forex Firms are the counterparties.

Consider the infamous failure of the largest (at the time) Bitcoin exchange, Mt. Gox, which filed for bankruptcy protection in Japan in 2014. The CFTC is trying to protect American retail customers from these types of losses.

Exemptions for ECP and ECE
Eligible Contract Participants (ECP) who meet certain high net worth requirements are “institutional” and exempt from CFTC regulations for American retail customers. ECP can trade off-exchange leveraged financial products, including Bitcoin derivatives. Eligible Commercial Entities (ECE) are exempt, too. (For a definition of ECP, click here and for ECE, click here.)

Republicans are interested in scaling back Dodd-Frank regulations
President Trump, his administration officials, and the GOP leaders in Congress have indicated they want to scale back elements of the Dodd-Frank Act. It’s conceivable they could reduce some of the CFTC limitations on American retail customers trading leveraged financial products off-exchange.

Tax reporting
Whether it’s legal or not under CFTC regulations, the IRS requires American resident taxpayers to report Bitcoin trading income and losses worldwide on U.S. resident tax returns. It doesn’t matter whether or not you repatriate funds back to the U.S. (See my blog post: If You Traded Bitcoin, You Should Report Capital Gains To The IRS.)

SEC large trader reporting rule

March 24, 2014 | By: Robert A. Green, CPA

Some high-frequency-trader (HFT) clients are receiving email notices from their brokerage firms advising them to file SEC Registration Form 13H to obtain a SEC Large Trader ID number (LTID). The broker needs that LTID in order to comply with the SEC Large Trader Reporting Rule, a rule that has been in place since 2011. (Broker-dealers were required to comply with the rules by April 30, 2012.)

In my view, regulators are keen on tackling — but not necessarily blocking — HFT. They need a better handle on HFT for their own reporting and accountability to Congress. Regulators are still concerned about the flash crash from May 2010, which, along with Congress, they blame on HFT. The first step in regulation is often registration light. It’s not public so your friends won’t see what you are up to. But, it will give the SEC a means to analyze what you are doing in the markets and it may react accordingly. Perhaps the SEC can request a broker to analyze all activity for a given LTID. Bottom line, this is more government oversight for HFT, but it’s not a burden of compliance or cost. (I don’t see any fee required with Form 13H.) It would be worse to have financial-transaction taxes – something we continue to fight against – and HFT trading restrictions. (New York’s Attorney General just blocked a data provider from giving an edge to HFT customers.)

Interactive Brokers includes a helpful summary of these SEC rules. The summary describes what the SEC is after:

“Large Trader” is defined as a person or entity who, directly or indirectly, through the exercise of “Investment Discretion,” effects transactions in exchange-listed equities and options that equal or exceed 2 million shares or $20 million during any calendar day, or 20 million shares or $200 million over the course of any calendar month … Calculating Options Traded. The Rule requires the calculation of shares and dollars of options traded as follows: Shares traded = option contracts traded * option multiplier (typically 100)… (similar option multiplier for ETFs and index options)…

… Initial Filing: A person must “promptly” file an initial Form 13H after its transactions reach the identifying activity level. The SEC states that under normal circumstances, “promptly” means 10 days.

The filing threshold is high and the filing requirement seems simple enough to do on your own. Of course, it’s always wise to consult a securities attorney with any questions.

Take a look at a manual SEC Form 13H with instructions, but note you must file it electronically with the SEC EDGAR system. It asks for basic information and not much else.

If you or your broker determines you should file SEC Form 13H, don’t miss the very short 10-day deadline. Not acting can cause you a bunch of trouble. I wonder if all brokers are set up properly to make this filing analysis.

Is U.S. Forex Trading Safe?

October 30, 2010 | By: Robert A. Green, CPA


Is U.S. Forex Trading Safe?

Is forex trading safe in the U.S. even with RFED or FCM duly registered brokers with the NFA/CFTC? U.S. forex brokers don’t have “segregation of asset” money protection rules, whereas futures brokers are subject to those rules. The new CFTC forex rules call for higher minimum net capital requirements for RFED forex brokers vs. futures brokers, so that helps cushion the concern about money protection issues. 

For warnings about hidden problems with forex brokers, see Erskine vs. CFTC 06-3896. The CEO of Rockwell Trading brought up this court case and discussed his concerns about forex brokers and their platform markets on our Oct. 27 Webinar. The CEO focused in on this quote in the case: This forex market, which is central to this case, is not a public market, but is instead a “negotiated market,” in which–according to the parties–foreign currency prices (the prices used for the trades in this case) are “constructed” by the FCMs using “software to process and distill currency prices offered by numerous banks and come up with an indicative market price.”

As I said on that Webinar, keep in mind that this court case occurred before the new CFTC forex brokerage rules went into effect on Oct. 18, 2010. The retail forex industry should be run better with the new rules. Later in the call, we circle back on the “segregation of asset” rules; we will try to do more research on it for next week. 

We noticed a troubling NFA news release dated Oct. 28, 2010 “NFA orders $459,000 monetary sanction against New Jersey forex firm Gain Capital Group LLC.” Read the text of the entire Complaint included in the release. 

Here’s another similar NFA fine of $320,000 against New York forex firm IKON Global Markets. Per the NFA release, “The Complaint alleged that IKON engaged in certain price slippage practices on the MetaTrader platform that were favorable to IKON and caused disadvantageous trading conditions for certain customers. The Complaint also charged that IKON failed to supervise the MetaTrader platform used for their forex business, and failed to supervise the firm’s operations.” I wonder if “slippage practices” are what Rockwell Trading CEO is warning us about?

The CFTC and NFA are scrutinizing forex brokers more now after their Oct. 18, 2010 effective date for RFED registrations in accordance with their new CFTC rules for forex transactions, sanctioned by Dodd-Frank Fin Reg too. The NFA website has several good new guides including Forex Transactions: A Regulatory Guide.

American forex traders are being forced to trade with no more than 50:1 leverage on the major currencies (20:1 on minors), FIFO (no hedging rule) and without any form of money protection. Because leverage with currency futures is not far off 50:1 (30:1 on the CME, for example), hedging may be easier with futures, and futures brokers must segregate assets for some protection. We will compare tax treatment between forex and futures next week. More forex traders may want to consider trading currency futures too.