Until recently, the forex markets were like the wild west, except there was no sheriff in town. As the number of complaints about dodgy forex operators have increased, US regulators have started to consider what regulation might be required for the forex markets. If you are interested in forex regulation, as you should be because this stuff will affect your bottom line, then read on.

The Zelner Loophole

In 2000, the US Congress as part of the Commodity Futures Regulation act gave some very basic levels of authority over Forex dealers operating in the US. The wording in that particular bill was pretty vague, and left a whole range of other players in the forex markets, such as introducing brokers, pretty much unregulated. Similarly, a land mark case in 2004 opened up what is known as the “Zelner” loophole which pretty much allowed off-exchange market makers to be free from the CFTC anti-fraud authority. The Zelner loophole effectively meant that the off market spot brokers were unregulated. So if you are wondering why most forex brokers you deal with are spot dealers and don’t support FX options or futures, it is because they are trying to sidestep being regulated.

Increasing the powers of the CFTC

Even though forex brokers make up less that 1 percent of the National Futures Association (NFA) membership, they make up 20% of all complaints and 50% of the enforcement docket. The levels of complaints about FX brokers has now caused US regulators to give the CFTC more power over the forex markets. This has meant the Zelner loop hole is now being closed.  Furthermore, introducing brokers are now subject to regulation and required to take a series 34 exam.

The final component has been for the CFTC also to increase the minimum capital requirements for off exchange forex brokers to prevent another Refco style disaster. By May 9 this year, the new minimums will be around 20 million dollars. If a broker comes with even 50% of this level, they will be required to notify the CFTC. This means the real minimum is closer to 30 million dollars. The net effect of this is we are likely to see consolidation of a lot of the smaller brokerage houses. Gone will be the days when someone has a spare million or two lying around, they buy metatrader server licenses and then they open up a forex brokerage. A lot of these 2 bit operations will either move overseas, close down or be bought out, Some players are aleady pulling out of the US forex market and mergers and acquisitions (M&A) teams are already sharpening their pencils.

While I think these moves are wholly positive, I think it may mean less competition in the market on spreads. When you consider that the Global Financial Crisis (GFC) has already caused brokers to raise their spreads, the glory days of super low spreads we saw in 2007 are pretty much over. The upshot of all of this is that between the GFC and regulation, scalping systems like FAP Turbo which depend on low spreads are likely to loose their edge.

The End of Hedging

In addition to the above new regulations, as of mid May,  NFA registered forex brokers will no longer offer hedging facilities. The ban on hedging will pretty much mean an end to some martingale systems (e.g. Forex Funnel) and grid trading systems (e.g. Pipforia HGM). Unless you are willing to use FX options this will mean that you are pretty much limited now to betting on he market direction using day, swing and position trading tactics.

What Next?

With the introduction of new regulations, the different groups are now pushing the CFTC to impose further constraints on the forex market. The next candidate I hear is up for consideration in the pipe line are around reducing the maximum leverage available.

FINRIA was lobbying the SEC to reduce leverage to 1.5:1. Fortunately FINRIA never got its way, because if it did it would have been the end of the retail forex market as we now know it as there would be very little point in trading it.

NFA on the other hand have moved one step closer in the space and are potentially going to propose that their brokers limit trading to 100:1 leverage for major pairs (e.g. the EUR/USD, GBP/USD, etc) and up to 25:1 for non-majors (e.g. commodity currencies, the crosses and exotics).

This entry was posted on Saturday, March 14th, 2009 at 4:03 pm and is filed under Currency Markets. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.