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"I’m confident that Congress will amend the law and that will help us deal with many of the problems in retail FX"
Dan Roth, NFA |
News that the US Commodity Futures Trading Commission (CFTC) has approved the National Futures Association’s (NFA) recommendation to increase the minimum net capital requirement for US forex dealer members (FDMs) from $1 million to $5 million will have been widely applauded by all legitimate firms operating in the retail sector. Those of a more shady persuasion will have been less pleased, especially as they will have a relatively short time to comply. They will also be perturbed by the fact that Dan Roth, the NFA’s president and chief executive, is calling for it to be raised substantially further.
The US retail foreign exchange market is often likened to the Wild West by industry observers and there is no doubt that it has attracted a lot of nefarious practices. It seems barely a week goes by when either the CFTC or NFA takes action or fines one of the FDMs. In testimony to the House of Representatives at the end of September, Roth highlighted the scale of the problem. "I testified before this subcommittee in 2003 and in 2005 about off-exchange forex futures that were being sold to retail customers. I stated then and believe now that certain provisions of the Commodity Futures Modernization Act of 2000 and subsequent case law had the unintended consequence of making unsophisticated retail customers the prey of fly-by-night operators," he said.
Roth added: "When I testified here in 2003, I told you that NFA Member FCMs held $170 million in retail customer funds trading off-exchange forex. Four years later, that number is now over $1 billion. With this dramatic growth there have been some pretty dramatic problems. Members acting as counterparties to retail forex transactions account for less that 1% of NFA’s membership. Unfortunately, they also account for over 20% of the customer complaints filed with our arbitration program, over 50% of NFA’s current enforcement docket and over 50% of the emergency enforcement actions NFA has taken over the last year."
Extra staff
In an interview with Euromoney, Roth says that the problem has become so large that retail FX now takes up around 25% of the time the NFA commits to compliance. As a result, it has had to recruit extra staff.
Looking at the regular financial data published by the CFTC (http://www.cftc.gov/marketreports/financialdataforfcms) on FDMs, it is clear that many of the companies providing retail FX will struggle to comply with the new requirement when it is implemented on December 21 2007. What will worry many more is Roth’s call to Congress to further increase the minimum net capital requirement to $20 million. Roth explained his rationale in his testimony. "The second trait that marks the problem firms in retail forex is that most, though not all, have been thinly capitalized," he said.
Roth believes he will get his wish and, if he does, it will almost certainly lead to a massive contraction in the sector. As it stands, just seven FDMs – FX Solutions, Interbank FX, Gain Capital, Forex Liquidity, GFT Forex, FXCM and Oanda – have deep enough pockets to comply. "I’m confident that Congress will amend the law and that will help us deal with many of the problems in retail FX. The problems with law-making though is the timetable. Fresh legislation takes time to get passed and introduced," Roth tells Euromoney.
However, Roth adds that there are other problems in the US retail market besides a lack of capitalization. "The nature of the enforcement actions we’ve taken cover a very wide range of misdemeanours. Some relate to misleading sales practices, while some result as a lack of capitalization and other problems. The nature of the problems don’t fit neatly into one bucket," he says.
A big issue for Roth is that because of its relatively light regulatory framework, FX has acted as a magnet for fraudsters. "We’ve even had incidents where people have been disciplined in futures and then they’ve moved across to FX. The fraudsters will always switch to what they see as unregulated markets," he says, adding that retail players in particular can be easy prey. "Retail customers can be vulnerable. Not protecting them is not good public policy."
Reputations
Roth says that the NFA routinely sounds out its FX members about proposed changes. "The members are generally supportive of what we’re trying to do. After all, a bad reputation is bad for business. The legitimate firms have a vested interest in ensuring that the reputation of their marketplace is as high as possible."
Transparency is part of the battle and while it has proved relatively easy for those who have had action taken against them to start afresh – often even operating out of the same premises – knowledge is being shared. "We routinely share information with foreign regulators and we do contact them if we take action against individuals or firms. Whenever we take disciplinary action, that information is available to everyone on our website. Furthermore, if we are ever contacted by foreign regulators, we would share all the information we have," adds Roth.
Roth is optimistic that the NFA will have success in cleaning up US retail FX. But he is under no illusions. "The battle is always an ongoing one. But I genuinely believe we will see a much higher level of compliance over time," he says.
He admits, however, that part of the problem for regulators is that there will always be fresh schemes and scams. "By its nature, regulation tends to be a game of action and then reaction," he says. Looking ahead, the increased participation of the big banks in retail FX is something the NFA appears keen on. "We welcome the participation of any firm that is committed to compliance," Roth concludes.