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Chapter Regulation:Past, Present,and Future he foreign exchange market has no central clearinghouse as do the stock market and the commodity futures market. Nor is it based in any one country; it is a complex, often freewheeling, loosely woven worldwide network of banks. This network is referred to as the Interbank system. Retail FOREX brokers—in different ways—tap into this network to fill their cus-tomers’ orders. These facts permeate every aspect of currency trading, especially the regulatory environment. It is difficult, if not impossible, to get a firm regu-latory grip on such an entity. That fact cuts both ways. The market is laissez-faire, but it is also a caveat emptor enterprise. If you wish to trade currencies, you must accept these facts from the beginning. Regulation in the FOREX Market In the second edition of Getting Started in Currency Trading, I wrote: The retail FOREX regulatory picture continues to evolve—slowly. Three years ago some broker-dealers proudly advertised they were not NFA members. Curiously one of those was REFCO, which failed soon thereafter. Today all of the major broker-dealers have joined the NFA (National Futures Association) and come under the watchful government eye of the CFTC (Commodity Futures 29 30 GETTING STARTED Trading Commission). My first advice to you: Do not trade with an unregistered broker-dealer. Every broker-dealer should have his NFA registration number on the web site’s home page. Regulation is seldom proactive; it usually is the result of a crisis. An NFA spokesman confessed to me that their hands were somewhat tied until a crisis provoked additional legislation. The NFA does host a booth at most FOREX trade shows. If you attend one of these, you might want to ask questions or voice your concerns to the people staffing them. They seem to be good listeners and keep close tabs on the pulse of the FOREX marketplace. Broker-dealers register as Futures Commission Merchants (FCMs). Currently, Introducing Brokers (IBs) can be covered by the FCM or register independently. As below, it is likely that IBs will all soon be required to register. Times have changed! In 2008 and 2009 the regulatory agencies in the United States have quickly evolved from a Casper Milquetoast to Magilla Gorilla. The CFTC and NFA have acted quite proactively. Appendix A, “How the FOREX Game Is Played,” outlines many of the issues for all parties that have prompted the fast-tracking of regulation in retail FOREX. Regulation Past In the beginning of retail FOREX, regulations, other than fraud statutes, were essentially non-existent. This was also true of the commodity futures markets up to the mid-1970s. The regulatory path of retail FOREX is following a remark-ably similar path to that of commodity futures in the 1970s and 1980s. The Commodity Futures Trading Commission (CFTC) In 1974 Congress created the Commodity Futures Trading Commission as the independent agency with the mandate to regulate commodity futures and options markets in the United States. The agency is chartered to protect market participants against manipulation, abusive trade practices, and fraud. Through effective oversight and regulation the CFTC enables the markets to better serve their important function in the nation’s economy, providing a mechanism for price discovery and a means of offsetting price risk. The CFTC also seeks to protect customers by requiring: (1) that registrants disclose market Regulation: Past, Present, and Future 31 risks and past performance to prospective customers (in the case of money man-agers and advisors); (2) that customer funds be kept in accounts separate (“seg-regated funds”) from their own use; and (3) that customer accounts be adjusted to reflect the current market value of their investments at the close of each trad-ing day (“clearing”). Futures accounts are technically safer than securities accounts because brokers must show a zero-zero balance sheet at the end of each trading session. TIP: The regulatory path of retail FOREX is closely following the path of commodity futures in the 1970s and 1980s—only the pace now has quickened. National Futures Association The CFTC was originally created under so-called Sunshine Laws, meaning that its continued existence would be evaluated vis-à-vis its effectiveness. As the futures industry exploded in the late 1970s, not only was its charter renewed but a separate quasi-private self-regulatory agency was created to implement the laws, rules, and regulations. Thus in 1982 was born the National Futures Association (NFA). The NFA is the CFTC’s face to the public and directs the regulatory and registration actions of the CFTC into the mar-ketplace. The NFA stipulates that members cannot transact business with non-members. So, for example, if your FOREX broker-dealer is an NFA member, it is not allowed to do business with nonmember money managers (Commodity Trading Advisors or CTAs). Commodity Futures Modernization Act of 2000 This was the first act by the CFTC pertaining to the then-emerging retail FOREX business. Beginning in the 1980s cross-border capital movements accelerated with the advent of computers, technology, and the Internet— extending market continuum through Asian, European, and American time zones. Transactions in foreign exchange rocketed from about $70 billion a day in the 1980s to more than $2 trillion a day two decades later. The Patriot Act A principal feature of the ubiquitous Patriot Act is the desire to limit money laundering so that large transactions might be followed, theoretically ensuring that funds are not headed to finance terrorist activities. It is obvious that such tracking will affect foreign exchange markets. You see reference to the Patriot Act on broker forms when you open an account. 32 GETTING STARTED The CFTC Reauthorization Act of 2005 The most critical legislation of interest to U.S. traders is the CFTC Reauthorization Act of 2005; it specifically addresses retail FOREX. The primary thrust of the Reauthorization Act and legislation currently pending is to require retail brokers to meet minimum capital requirements. The new minimum is $20,000,000—up from $5,000,000 just three years ago and no minimum 10 years back. A number of mergers have already taken place. The NFA is also enacting a Know Thy Customer rule for FCMs. This will require them to undertake a more proactive due diligence of prospective clients and their suit-ability for currency trading. One effect of this will probably be to eliminate account-funding options by PayPal and other electronic transfers except for bank wires. Traders may wish to periodically check FOREX broker-dealer financials here: www.cftc.gov. Retail FOREX seems to be following a path parallel to retail futures in the 1970s and 1980s. As predicted in the second edition, Introducing Brokers (IBs) are now required to register and meet minimal capital requirements. I expect mergers between the majors within the next several years as competition, smaller profit margins, and lower growth rates loom. Similar slow-but-sure regulation of retail FOREX is occurring in other countries. Brokers not domiciled in the United States also should register with the NFA if they desire to prospect and accept accounts from U.S. citizens. The Financial Markets Association (FMA) has suggested international for-eign exchange regulatory standards. FMA’s model code currently has regulatory standing in Australia, Austria, Canada, Cyprus, Hong Kong, Malaysia, Malta, Mauritius, the Philippines, Slovenia, and Switzerland. Countries with specific agencies regulating FOREX: United Kingdom— Financial Services Authority (FSA); Australia—Australian Securities and Investment Commission (ASIC); Switzerland—requires registration as a Financial Intermediary under Swiss Federal Law; Canada—Investment Canada, Federal Competition Bureau. Regulation Past of the retail FOREX industry could be considered mild and somewhat tentative. But in early 2008 the NFA and the CFTC began to put some teeth into their regulatory oversight with major new compliance rules. Regulation Present Government regulation often is an all-or-nothing effort. For the first 10 years of retail FOREX the CFTC and NFA did little. To be sure, part of the reason was that it took time to get a handle on this loose, freewheeling, and widely dissem-inated business. Regulation: Past, Present, and Future 33 In 2008 and 2009 these agencies poured out new regulations at a ferocious pace—usually without requesting much in the way of feedback from market participants. When I discussed the proposed Compliance Rule 2-43 with an NFA representative at a FOREX trade show in August 2008, I was assured it would be slow in coming and there would be a substantial comment period. Not so. To some extent the economic meltdown of 2008 encouraged this fast-track mode. The new NFA Compliance Rule 2-43 has wrought havoc on brokers as well as traders. The latest regulations concerning hedging, order placement (First In First Out; FIFO), and money manager registration has sent U.S.-based brokers scurrying to find overseas affiliates that are beyond the reach of the NFA and CFTC. One incentive for brokers: Traders do not like the new regulations either and many are moving their accounts and their money overseas. To that extent, the regulation’s purpose of protecting U.S. citizens who trade FOREX may be partially counterproductive. In late 2009 brokers found that they had to quickly make major changes to their trading platforms to accommodate the new FIFO and hedging regula-tions. The sense in the industry was that regulations were made without regard to what was involved in making them work. For example, one of the major independent trading platforms planning to release an updated version in the summer of 2009 was sent “back to the drawing board” at the last minute to implement the necessary code into their software. The situation for most of the summer and fall of 2009 could only be considered as chaotic. The government often carries a hatchet and meat cleaver when a scalpel and carving knife would have done the job. Nonetheless, those who complain that regulations are typically reactive cannot fault the proactive work of these agencies recently. TIP: No government, no agency, no regulation can prevent fraud com-pletely. The best protection for traders is knowledge, education, and a firm understanding of what caveat emptor means and implies. NFA Compliance Rule 2-43 The regulation that has dropped on the industry like a bomb is NFA Compliance Rule 2-43. Although 2-43 addresses many issues, the two most important are Anti-Hedging and FIFO. Anti-Hedging Anti-hedging has been the most controversial new regulation. It has, in many ways, turned the retail FOREX business on its head—at least for the moment. Traders are prohibited from entering and brokers are pro-hibited from accepting orders that would place a trader on both sides (buy and sell) of any currency pair. Traders use speculative hedging for a wide ... - tailieumienphi.vn