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.
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.)