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January 22nd 2010

New CFTC Forex Regulations Unpopular, but Worthwhile

I try not to editorialize much when writing this blog. There are too many talking heads as it is, which is why I try not to interject own opinions into the facts. Admittedly, the notion of facts in forex is obviously a bit murky, but I stand by my approach, nonetheless. Today, I would like your permission to stray from the facts (well, not entirely) and offer my opinion on the recently proposed regulatory overhaul for trading forex.

For those of you who haven’t been following this story, let me give you an overview. On January, the U.S. Commodities Futures Trading Commission (CFTC) proposed a set of sweeping changes to the rules that currently govern forex trading in the US. Among the changes are beefed-up requirements for forex dealers which would be legally required to register with the CFTC as “retail foreign exchange dealers”, and satisfy certain capital adequacy requirements, aimed at mitigating counter-party risk (i.e. dealer bankruptcy.) In addition, “introducing brokers,” (i.e. those that act as intermediaries between customers and dealers) would be required to sign exclusivity agreements with dealers, who would in turn be required to vouch for their brokers. Last, but not least, would be a bombshell change that would shrink leverage (i.e. raise margin requirements) to a maximum of 10:1.

We have are now partially through a 60-day “comment period,” during which the CFTC is soliciting feedback from stakeholders to determine if and in what form it should ratify these changes. And feedback is indeed reverberating around the blogosphere (more so than traditional media, based on my observation). Most industry insiders are predictably opposed to the regulation, on the grounds that it will make them less competitive with their (lightly regulated) foreign counterparts. Based on an online poll, it seems the majority of forex traders are as well. On forums, many have promised to shift their accounts overseas (or are gloating about already having done so) as soon as the measures pass. Meanwhile, the blogger to come out most prominently in favor of the regulation, is none other than Karl Denninger, who champions the the potential increase in transparency in decrease as leverage, but notes that it will probably bring about the “Death of Retail Forex.”

Personally, I am inclined to agree with Denninger (though not his flawed math, nor his erroneous tirade against rollover fees), on the grounds that transparency – especially with regard to commissions, which are dissimulated and ultimately buried in spreads – can only benefit customers. In addition, requiring all brokers and dealers to register, while strengthening the CFTC’s jurisdiction over forex will surely go a long way towards minimizing fraud, which remains rampant and in disguise, even among major brokers. Interestingly, industry lobbyists have come out in tepid support of this measure, but only because it will also raise the barriers of the entry.

As for the clause that aims to limit margin – and is really the only one that anyone is seriously protesting – this is also a step in the right direction. While libertarians and the 1% of traders that have turned a profit employing 100:1 leverage (the current U.S industry standard) will surely disagree, I think that sometimes, people need to be protected from themselves. I don’t want to frame this debate in political terms, however, since at the end of the day, such high leverage is both de-stabilizing to the market, and unnecessary. It’s destabilizing, because of the massive speculation it invites, and its resulting contribution to volatility and systemic risk, and unnecessary because it’s impossible to produce a viable trading strategy that’s built on borrowing 100 times as much money as you are able to commit. For the sake of comparison, consider that the average hedge fund, its reputation for excessive risk-taking not withstanding, will rarely employ leverage greater than 2:1. How about another comparison: Has 100:1 leverage (i.e. 1% down-payment) been good for the housing market, from both the standpoint of individual and society?

As for the argument that retail traders will instead send their money off-shore to gamble (cough, I mean trade), well I suppose that’s possible. But given that a related piece of  recent regulation has been very successful at preventing Americans from patronizing offshore casinos, I’m sure the government can ensure a high rate of adherence with this piece as well. But obviously, this too, is a highly charged political issue, and it’s probably not practical to examine forex from this angle.

In the end, I think the government has (rightly) identified retail forex as the casino it is, and is finally taking steps to make it legitimate. For regular readers of the Forex Blog and those that follow its implicit approach (i.e. not churning your portfolio on a daily, or even weekly basis), I am confident that this regulation, if approved, will NOT adversely affect you. As for everyone else, maybe it’s time to either re-think your strategy, or ask yourself whether trading forex is still right for you.

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Posted by Adam Kritzer | in Commentary, Investing & Trading, News | 25 Comments »

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25 Comments of “New CFTC Forex Regulations Unpopular, but Worthwhile”

  1. Michael Greenberg Says:

    Adam,

    US retail forex is far far from being the “casino” that it was 4-5 years ago. NFA’s unpopular requirements like anti hedging and the increase of net capital have indeed made the industry a bit more transparent, though harming many innocents in the process.

    Another thing I find inaccurate in what you write is the notion that “offshore” is a synonym for thieves and cheats. In your opinion any “offshore”, that is non-US, brokers are essentially bad guys. And trading with them is gambling as opposed to “trading” with US brokers.

    This is absolutely wrong, one might even say it’s a generalization and a case of xenophobia.

    Bad brokers come and go, and there were as many bad brokers in the US as there were in other “offshore” parts of the world. May I remind you of Refco, or other lower profiled cases – just search NFA’s website – all brokers were charged with this or that type of scam, they just settle to make it look it better.

  2. Charles Says:

    I think FB is one of the best financial sites, one that I value reading. If editorializing a bit keeps you writing, then editorializing is fine by me.

    As for Michael’s complaint that you have in any way denigrated off-shore businesses, it’s inaccurate. Nothing you have written can be construed to criticize offshore businesses. All you said was that it proved possible to regulate other brokers, called “casinos” when they chose to move offshore.

    Michael’s complaint is also misguided. When there is a crash (or even a simple complaint of pip shaving, like Dickten’s), and people want to get their money back, it’s usually a whole lot easier if the broker is onshore.

    Furthermore, while many of the offshore operators may be saints, pickpockets prefer to operate where there are no streetlights. All things being equal, the bad guys will choose to locate where there is no regulation.

  3. Mike Says:

    Just another way for the rich to get richer, and keep the regular guy out of the game.

  4. CFTC proposed a set of sweeping changes to the rules Says:

    […] can go here and read the full article – when you’re done, make sure to come back here and leave […]

  5. John Riley Says:

    Anyone who does not see that the attempt to drastically raise margin is an attempt to destroy retail forex is an idiot. Brokers have recently raised minimums from 400 to 1 TO 100 to 1 through voluntary agreement. Cutting to 10:1 would make Forex trading absurd for snall traders. But of course, Obama is a very bright boy who knows all this but still knows what is best for us all. All the brilliant business men who supported Obama with votes and money shoold be shot for terminal stupidity.

  6. Mark M Says:

    One thing you can count on and that is if retail forex goes away so does this blog. After reading this elitist crap of an article I won’t complain.

  7. Michael Greenberg Says:

    Hi Charles,

    When there is a crash (or even a simple complaint of pip shaving, like Dickten’s), and people want to get their money back, it’s usually a whole lot easier if the broker is onshore.

    Tell that to Refco and Madoff’s investors. When money is lost it’s lost.

  8. Jeanette Strother Says:

    Adam, quit trying to save us. Go play in the traffic.

  9. Jason Macko Says:

    Are you a day trader? Do you trade in the spot market?

    I think these regulations are designed for hands off forex traders that watch f*ing bloomberg at night, catch the forex segment and buy x contracts of what the specialist say they should buy, then wonder why their position is in negative value by y hundred pips at the end of the week – then we hear complaints about the lack of stability. The leverage change is also designed with the large players interests in mind such as banks, hedge funds, etc that will have even more leverage over the limited-capital traders. Basically it will make the field even more lopsided and force a ton of margin calls on limited capital investors while adding x billion in reveue to Goldman’s next yearly statement and 10 points to their share price, then the government can say – look we listened to the public and cracked down on excessive risk taking and we saved the economy, – see we might have no new jobs, but look Goldman F*ing Sachs share price went up 10 points, we’re in recovery!

    The claim of protecting the small investor is dubious at best. An undisciplined and reckless trader will liquidate their account regardless of the margin they are allotted, 400:1, 100:1, 10:1, 5:1, 1:2, whatever; leaverage is irrelevant if someone is exposing more than an acceptable percentage of their account. The only way to protect these people is to either tell them to learn the market, operate with discipline, limit their exposure until they learn, or tell them to invest elsewhere.

  10. Adam Kritzer Says:

    Michael,

    I apologize for the confusion that my reference to offshore brokers generated. If you re-read this post, you’ll notice that I didn’t make any denigrating comments about such offshore brokers. My point was to distinguish trading from gambling; if US brokers are barred from offering 400:1 leverage, then retail investors that want to gamble with such high leverage will have no choice but to go overseas.

    I agree that retail forex is certainly not the “casino” it was a few years ago, but I stand by my argument that it would benefit from increased regulation and transparency, and that leverage in excess of 10:1 is almost always tantamount to gambling.

    adam

  11. Jason Says:

    “People need to be protected from themselves”??

    WHO DO YOU THINK YOU ARE?

    This law is like someone coming to you and saying ok Adam, you want to go buy a car for $10,000?

    You must hae $100,000 in the bank to buy it.

    Why? Well, we feel you really can’t afford a $10,000 car unless you have $100,000 in cash. We’re just looking out for you!

    IT’S INSANE! BIG BROTHER TELLING YOU HOW MUCH OF YOUR MONEY YOU CAN SPEND AND WHERE.

    What about Las Vegas?? You can take $100,000 to Vegas put it all down on one hand of blackhack and lose it. WHY ISN’T THE GOVERNMENT REGULATING LAS VEGAS?

    Ten times more of a risk.

    Forgetting one big point Adam, BECAUSE of the leverage of 100 to 1, people are actually typically risking LESS money in the Forex market and are able to learn with smaller accounts, unlike the stock market, where if you have even a great day trade account, you can get 4-1 leverage for day trading. So, the Stock market will be next. They’ll tell people you can only use 1:1 or 2:1 on day trades.

    HOW ARE WE SUPPOSED TO MAKE MONEY? Pay more taxes to government first off, then second, they tell us how we can and where we can spend the money we make? Because they’re “looking out for us”??

    Ridiculous.

  12. Jurisdiction issues in retail forex. Who will win the turf battle: CFTC or SEC? | Forex Blog Says:

    […] in light of the proposed changes in forex regulation that have generated a heated response on this blog and elsewhere, I want to offer some insight into a tangential issue: […]

  13. mike Says:

    vote for the Republicans if you don’t like it. This is who you voted for. You knew he was radical by the people he associates with.

  14. Chuck Elliott Says:

    Adam,
    I agree completely with Mike, John, Mark, Jeanette, and Jason.
    You are an idiot and people like you can’t see that the likes of Gary Gensler (former Goldman Partner), Michael Dunn
    (Farmers Home Administration) and Bart Chilton are all liberal progressives trying to beat down the producers in our country so they can control how to take and distribute the wealth in a way to keep their power! “Atlas Shrugged” Go read it! You do not understand liquidity, volatility, or markets.

  15. Mike Says:

    Forex is an online casino? I suppose next you’re going to tell us that the commodities and stock exchanges are likewise as well. Don’t you understand what the foreign exchange market is? This is the trading of one currency pair against another. There are many economic, political and governmental factors that affect the currency exchange rates. Currencies are the basis on which the entire planet’s trading systems are based on. This is a lot different than placing chips against the spin of a roulette wheel in a gambling casino.

    And how about the retail forex dealers and their customers going overseas now, where there are not only more leverage options available, but investment hedging as well?

    And you’re the author of a forex blog? LOL Or perhaps you’re just part of the liberal left wing economic agenda that’s currently sweeping this country. You know, the one that frowns upon the entrepreneurial spirit on which this country was founded on. The one that robs from the rich to give to the poor.

  16. Terry Rowlings Says:

    If I trade 1 Lot of my 100K account and make 10 pips I make $100 profit. If I trade 100 Lots of my Base10 account I make $100 profit. I prefer use the number of Lots I trade for my leverage rather than 100:1 or 400:1 leverage. Using my 2% risk rule I increase Lot sizes more regularly as my balance grows with a Base10 account than I can with a 100k account (the steps are smaller). Over the course of a year there is little difference in the results between the two approaches. I just prefer to increase Lot sizes as the means of leverage. Unless I am misunderstanding the proposed regulatory change to 10:1 leverage, I cannot see the problem.

  17. Ian K. Says:

    So now it is Sept. 2010, how is Obama looking now. See how well he can regulate the the smell guy trading a small account & yet the banks still run the show.

  18. Michael Pillos Says:

    Been in charge of communications in one of Europe’s oldest Forex Brokers I feel a tremendous reward and satisfaction in the recent developments & “Limitations” in U.S CFTC Forex Trading regulation. It’s been a long standing argument of mine that we have liability in how we communicate our products and services to the world (specifically to the new customers). The Online Forex industry has been transformed in the last 4-5 years to a glorified casino rather than a complicated multi-faced financial OTC instrument (…and so has the Marketing approach of several Forex “brokers”). We hope that the new legislation will soon be applied to Europe and the rest of the world so that solid, self respecting brokers can proceed serving the Markets.
    Michael from TFI Markets

  19. John Says:

    With 100k, of course you can not see the problem. What about the average Joe with only 10-20k in his account?

  20. Polo Says:

    When goverment start to inmerse it infamous nouse, there is a trouble!!. As Lincoln said “the Goverment can not do for a man what a man have to do for himself”. People get into trade by his steps, no body force you, EVERYONE IS RESPONSIBLE FOR HIS DECICIONS,not the goverment,
    The leverage you use shall be acording to your risk and money management that is diferent for EVERYBODY, that why
    People are not free in a comunist country!!!
    One more: When you see a President every day on TV, and had wrote 6 to 10 books on Barnes and novel since become president …
    QUESTION: When did the president take care of America???

  21. nyongesa Says:

    The U.S. Government has decided that within their domain they will not allow more than 50:1 leverage… OK!, it is a democracy after all, BUT!!!!!, what incenses me, is the Rule that as a U.S. Citizen I cannot chose to trade elsewhere….THAT REALLY BURNS ME…that is the definition of tyranny, it maybe the soft cushy kind of tyranny, but tyranny all the same …

  22. Gerald Says:

    Casino my butt, 40% a month casino for me 🙂

  23. hendrian / ID Says:

    I agree with the new CFTC regulations, I think that not about traders. but how to control forex broker game !.

  24. hendrian / ID Says:

    of “arbitrarily setting prices without any correlation to the prevailing spot prices on the interbank market; setting arbitrary and unreasonably wide bid-ask spreads; arbitrarily “spiking” prices to trigger stop orders and margin calls; and filling market orders that routinely suffered from substantial and unjustifiable slippage.”

  25. Anthony Says:

    I agree with Hendrian/ID in that there are certain aspects of the forex trading that do need to be appropriately regulated. On the flipside, the CFTC has chosen to regulate the wrong things, such as enforcing low leverage of 50:1, not allowing the use of hedging, and not allowing US citizens the choice of taking their business elsewhere if they don’t like how it is done in the US. Seriously…how is it that EVERYONE ELSE on the planet is doing perfectly fine trading forex the way it is, and it is supposedly so much better for US residents with these restrictions? In all honesty, when you look at what has been regulated and how, it becomes VERY obvious that the wealthy are trying to keep the poor from being able to become wealthy. That 500:1 leverage that is, supposedly, so bad for me allows me to make a $1000/week with only a $10,000 account…without high risk. Using 50:1 leverage, and no hedging, I was able to make $400/week…with INSANELY high risk. The margin requirement is so high that to make a decent amount…the threat of margin call is constantly looming on the horizon….Unless, of course, I have $100,000 or more in my account. These regulations are specifically intended to keep poor people from using the forex to get rich. No matter how you look at it, it ALWAYS comes back to this.

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