Off-Exchange Forex Regulation
|Proposal Date||Final Rule Issue||Effective Date|
|January 20, 2010||September 10, 2010||October 18, 2010|
|Proposal Date||Final Rule Issue||Effective Date|
|April 22, 2011||July 14, 2011||July 15, 2011|
|Proposal Date||Final Rule Issue||Effective Date|
|May 10, 2011||July 8, 2011||July 15, 2011|
|Proposal Date||Comment Deadline||Final Rule Issue|
|July 28, 2011||October 11, 2011||April 9, 2013|
On September 10, 2010, the CFTC approved its final rules regarding off-exchange retail foreign exchange transactions. Although the rulemaking pre-dated the Dodd-Frank Act, once the Act was signed in July 2010, the commission's forex rules, along with the forex rules of other regulatory authorities, became a part of Dodd-Frank. Under Dodd-Frank, the CFTC will have jurisdiction over retail foreign exchange transactions, except in the case of entities which fall under the authority of one of the following regulatory agencies ("Prudential Regulators"):
- Office of the Comptroller of the Currency, Treasury (OCC);
- Board of Governors of the Federal Reserve System (Fed);
- Federal Deposit Insurance Corporation (FDIC);
- Farm Credit Administration (FCA); and
- Federal Housing Finance Agency (FHFA)
The Act requires that such rules include appropriate requirements with respect to disclosure, record keeping, capital and margin, reporting, business conduct, documentation, and any other standards or requirements as Federal regulatory agencies shall determine to be necessary.
CFTC Final Rule: Off-Exchange Retail Forex
The Commission’s final rules closely mirrored those of the proposed rules from January, 2010:
- The CFTC rule primarily addresses the amount of leverage retail traders can employ in trading off-exchange currencies. The rule allows for a maximum of 50 to 1 leverage, or a 2 percent margin requirement on major currency pairs, and a 20 to 1 maximum leverage on all other forex transactions, or a 5 percent requirement. This was the major deviation from the proposed rule, which limited leverage to a 10 to 1 ratio.
- The proposed requirement that a person who registers as an Introducing Broker (IB) to introduce retail forex accounts must be guaranteed by a registered FCM or Retail Foreign Exchange Dealer (RFED) (and that the IB could be guaranteed by only one FCM or RFED) was replaced with the same requirement that currently applies to IBs who introduce futures and commodity interest accounts. A forex IB may choose either to meet the minimum net capital requirements applicable to futures and commodity options IBs, or to enter into a guarantee agreement with an FCM or an RFED.
- FCMs, or RFEDs must also maintain a net capital of $20 million, plus 5 percent of the amount, if any, by which retail forex customer liabilities exceed $10 million. The NFA is authorized to set specific security deposit levels within those parameters, and is required to review periodically and adjust as necessary both the particular security deposit levels and the designation of which currencies are “major” currencies, in light of such factors as changes in volatility.
- The final rules retain the requirement for RFEDs and FCMs that engage in retail forex transactions to disclose on a quarterly basis the percentage of non-discretionary accounts that realized a profit and to keep and make available records of that calculation.<ref>Questions and Answers Regarding Final Retail Foreign Exchange Rule. CFTC. Retrieved on January 20, 2011.</ref>
The rules went into effect on October 18, 2010.
In early 2011, prudential regulators submitted proposed rules and requests for comment on forex regulation. While these proposals generally mirror the CFTC Final Rule, minor differences such as dispute resolution vary among regulators. Documents related to these rule proposals can be found below, under Prudential Regulators' Forex Regulation.
Retail Transaction Definitions
- A retail forex customer is generally defined by the CFTC as: An individual with less than $10 million in total assets, or less than $5 million in total assets if entering into the transaction to manage risk, and is not registered as a futures or securities profession.
- Companies, other than financial institutions and investment companies, with less than $10 million in total assets, or a net worth less than $1 million if entering into the transaction in connection with the conduct of their businesses; and commodity pools with less than $5 million in total assets.
According to the Dodd-Frank Act, the list of eligible companies who may serve as counterparties to off-exchange retail forex transaction, only U.S. financial institutions are allowed to act as counterparties. Insurance companies are no longer allowed to participate as counterparties.
The CFTC stated that regulation of the retail forex space depends on the type of firm which will act as a counterparty. If an SEC registered broker or dealer is handling retail forex will be regulated by that agency. Financial institutions will be regulated by banking regulators (see Prudential Regulators Forex Proposals below). The CFTC has jurisdiction over FCMs, RFEDs, or entities not otherwise regulated.
None of the provisions have any impact on exchange-traded forex contracts.
CFTC Guidance to Forex Commodity Trading Advisors and Commodity Pool Operators, February 27, 2012
On February 27, 2012, the CFTC Division od Swap Dealer and Intermediary Oversight issued a letter of guidance to the National Futures Association (NFA) regarding the CFTC Retail Forex rules and performance disclosure by CPOs and CTAs. According to the letter:
"It is the Division’s view...that a Forex CTA is required to disclose past performance for the period beginning October 18, 2010, or, if later, the date on which the Forex CTA first began exercising discretionary trading authority over accounts engaged in retail forex transactions. From and after October 18, 2015, the period of time described in Regulation 4.35(a)(5) (five most recent calendar years and year-to-date or life of the trading program, if shorter) would apply.
"If a Forex CTA elects to include in its Disclosure Document past performance information for any time prior to October 18, 2010, we believe that in order to avoid “cherry picking” the presentation of such information should encompass the entire period set forth in Regulation 4.35(a)(5) and should include all of the accounts over which the Forex CTA exercised discretionary trading authority during that period."
The full text of the letter can be found below.
Prudential Regulators Forex Rules
Final Rule, Office of the Comptroller of the Currency (OCC), July 14, 2011
On July 14, 2011, the Federal Register published a final rule from the OCC regarding the authorization of national banks, federal branches and agencies of foreign banks, and their operating subsidiaries (collectively, national banks) to engage in certain off-exchange transactions in foreign currency with retail customers. According to the final rule, such a retail transaction is defined as "a transaction in foreign currency between a national bank and a retail customer that is:
- a future or option on such a future;
- an option not traded or executed on a registered national securities exchange; or
- a certain leveraged or margined transaction.
The rule became effective on July 15, 2011. Additionally, as mandated in the Dodd-Frank Act, on July 21, 2011, the OCC replaced the Office of Thrift Supervision as the appropriate Federal banking agency for Federal savings associations. A separate order addressing the expansion of the rules to Federal savings associations appeared in the Federal Register on September 12, 2011. <ref>Retail Foreign Exchange Transactions. Federal Register. Retrieved on September 12, 2011.</ref>
The requirements are similar to the Final Rule Regulating Off Exchange Retail Foreign Exchange Transactions from the CFTC, September 10, 2010. The deadline for public comment was May 23, 2011. The final rulemaking, as it appeared in the Federal Register on July 14, 2011, can be found below.
Final Rule, FDIC, July 8, 2011
On May 10, 2011, the Federal Deposit Insurance Corporation (FDIC) issued a rule proposal regarding retail forex transactions engaged in by insured depository institutions (IDIs) under FDIC authority. Under the proposed rule, retail customers with relationships with a bank, and are not cleared through an exchange, will be required to post a margin of 2 percent in major currencies such as the U.S. dollar, yen or euro. The margin amount would rise to 5 percent of the notional value of the transaction on other currencies, according to a Reuters story on the FDIC rule. This rule does not affect large companies, only retail customers who are defined as individuals with less than $10 million in assets.<ref>U.S. FDIC unveils retail foreign exchange rule. Reuters. Retrieved on May 16, 2011.</ref>
The final rule applies to foreign currency futures, options on futures, and options as these terms are used in the Commodity Exchange Act. The rule would also apply to transactions that are "functionally or economically similar" to futures and options, such as "rolling spot" trades. Highlights of the rule:
- FDIC-supervised IDIs entering into trades covered by the rule would be subject to requirements in six areas: disclosure, recordkeeping, capital and margin, reporting, business conduct, and documentation. The requirements focus on safety and soundness and consumer protection.
- Traditional spot and forward contracts would not be covered by this rule.
- The rule would only apply to covered transactions with a retail customer. For purposes of the rule, a retail customer may include certain small businesses. It may also include an individual with $10 million or less invested on a discretionary basis and who is not using the trades to reduce risks associated with other investments.
- FDIC-supervised IDIs engaged in or that wish to engage in transactions covered by the rule would be required to submit a detailed business plan, demonstrate board approval of the activity, and obtain written approval from the FDIC to provide such products, among other requirements.
- FDIC-supervised IDIs engaged in this or any sales or marketing of any investment products should continue to meet the expectations set out in the 1994 Interagency Statement on Retail Sales of Nondeposit Investment Products to the extent such expectations do not conflict with the requirements of the final rule.<ref>Retail Foreign Exchange Transactions. FDIC. Retrieved on July 11, 2011.</ref>
Federal Reserve Rule Proposal, July 28, 2011
The Federal Reserve issued its rule proposal and request for public comment on July 28, 2011. The comment deadline is October 11, 2011. To submit a comment click here.
The proposal is modeled, in general, after the CFTC Final Rule on Off-Exchange Forex (see above), with a few key differences:
- The proposal does not include registration requirements, because banking institutions are already subject to comprehensive supervision by the Board. Thus, instead of a registration requirement, banking institutions must provide 60 days notice to the Board to conduct a retail forex business.
- Because banking institutions are already subject to various capital and other supervisory requirements, the Board’s proposed retail forex rule generally requires banking institutions wishing to engage in retail forex transactions to be "well capitalized."
- The proposed rule would require that the risk disclosure statement highlight that a retail forex transaction is not insured by the FDIC. The CFTC’s regulations do not address FDIC insurance because no financial intermediaries under the CFTC’s jurisdiction are insured depository institutions.
- The Board is not proposing to require a separate retail forex margin account, but is requesting comment on whether these prohibitions would be appropriate. OCC and FDIC forex rules, will require such separation.
- Similar to the FDIC rule above, the Fed's proposal would bar the use of mandatory pre-dispute arbitration agreements. In contrast, the FDIC and OCC rules permit the use of pre-dispute arbitration.
Related Documents: CFTC, FDIC, OCC, Federal Reserve Rules as Entered into the Federal Register; CFTC Interpretive Guidance to Forex CTAs