Answers Regarding Prohibition of Hedging Spot Forex Transactions
(www.hedgefundlawblog.com) The NFA has certainly taken a lot of heat over its controversial rule to ban the practice of “hedging” in a single spot forex account. Many retail investors have already begun establishing brokerage accounts offshore in order to utilize this trading strategy. I recently talked with a compliance person at the NFA and they said that they are aware that US persons are going to offshore forex brokers in order to utilize this trading strategy. We will see if in the future the NFA relents on this issue, but for now the NFA has provided guidance on some of the more technical aspects of the new Compliance Rule 2-43.
The NFA guidance is reprinted in full below and can also be found here.
NFA Compliance Rule 2-43 Q & A
NFA has received a number of inquiries regarding the application of new NFA Compliance Rule 2-43. This Q & A answers the most common questions.
CR 2-43(a), Price Adjustments
Q. Section (a)(1)(i) of the rule provides an exception from the prohibition on price adjustments where the adjustment is favorable to the customer and is done as part of the settlement of a customer complaint. Does that mean a Forex Dealer Member (“FDM”) can’t make a favorable adjustment if the customer does not complain?
A. It depends on the circumstances. The intent of this provision is to ensure that FDMs can settle customer complaints before or after they end up in arbitration. It was not meant to prohibit FDMs from adjusting prices on customer orders that were adversely affected by a glitch in the FDM’s platform. A firm may not, however, adjust prices on customer orders that benefited from the error (except as provided in section (a)(1)(ii)). Furthermore, an FDM may not cherry-pick which accounts to adjust.
Q. An FDM operates several trading platforms. Two provide exclusively straight-through processing, but one does not. Can the FDM make section (a)(1)(ii) adjustments for trades placed on the two platforms that provide straight-through processing?
A. No. The Board intended to limit the relief to those firms that exclusively operate a straight-through processing business model, and the submission letter to the CFTC uses this language when explaining the rule’s intent. NFA recognizes, however, that the use of the word “platform” in the rule itself may be confusing, and we intend to ask the Board to eliminate that word at its August meeting.
Q. For price adjustments made under section (a)(1)(ii), the rule requires written notification to customers within fifteen minutes. If the liquidity provider informs an FDM of the price change twenty minutes after the orders are executed, can the FDM still make the adjustment?
A. No. The rule provides that customers must be notified within fifteen minutes after their orders are executed, and it was written that way intentionally. Since a customer’s subsequent trading decisions may be based on the customer’s belief that a particular trade was executed at a particular price, the rule provides a narrow window for price adjustments.
 For purposes of this discussion, the term “adjustment” also refers to cancellations.
CR 2-43(b), Offsetting Transactions
Q. CR 2-43(b) states that an FDM cannot carry offsetting positions. If a customer with a long position executes a sell order or a customer with a short position executes a buy order, does the FDM have to close the position immediately or can it wait until the end of the day?
A. The FDM may wait until the end of the day to offset the positions, but it must do so before applying roll fees.
Q. The rule provides that positions must be offset on a first-in-first-out (FIFO) basis. If the customer places a stop order on a newer likesize position and the stop is hit, may the FDM offset the executed stop against that position?
A. No. The only exception to the FIFO rule is where a customer directs the FDM to offset a same-size transaction, but even then the offset must be applied to the oldest transaction of that size.
Q. One of an FDM’s platforms is offered exclusively to eligible contract participants (ECPs). Does Rule 2-43 apply to transactions on that platform?
A. No. Rule 2-43 does not apply to transactions with ECPs.
Q. May an FDM transfer foreign customers to a foreign entity that allows customers to carry offsetting positions in a single account?
A. Yes. If done as a bulk transfer, however, the Interpretive Notice to NFA Compliance Rule 2-40 (located at ¶ 9058 of the NFA Manual) requires that the foreign entity must be an authorized counterparty under section 2(c) of the Commodity Exchange Act (CEA).
Q. May an FDM transfer U.S. customers to a foreign entity that allows customers to carry offsetting positions in a single account?
A. Only if the transactions are not off-exchange futures contracts or options. The legal status of “spot” OTC transactions that are continually rolled over and almost always closed through offset rather than delivery is currently unsettled. Therefore, if an FDM chooses to transfer U.S. customers to a foreign entity so they can continue “hedging,” it does so at its own risk. In any event, a bulk transfer can only be made to a counterparty authorized under the CEA.
Q. If the transactions are not futures or options, does that mean none of NFA’s rules apply?
A. Most of NFA’s forex rules do not depend on how the off-exchange transactions are classified. This includes Compliance Rule 2-36(b)(1), which prohibits deceptive behavior, and Compliance Rule 2-36(c), which requires FDMs to observe high standards of commercial honor and just and equitable principles of trade. An FDM that misrepresents the characteristics of “hedging” transactions (e.g., by touting their “benefits”) or NFA’s purpose in banning them or that implies that transferring U.S. customers offshore will make the transactions legal violates those sections of CR 2-36. Furthermore, NFA Compliance Rule 2-39 applies these same requirements to solicitors and account managers.
Please feel free to contact us if you are interested in starting a forex hedge fund or a forex managed account. Other related forex law and regulation articles include: