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NFA Discusses Recent Forex Regulations

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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.

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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[1]

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.

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[1] 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.
Related Issues

Related Issues

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.

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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:

NFA Takes Regulatory Aim at Spot Commodities Markets

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Asks Congress to Increase Scope of Regulation for CFTC and NFA

Last week various employees of the CFTC and the NFA talked with members of Congress regarding certain aspects of the markets regulated by these groups.  Below is testimony from the Chief Operating Officer of the NFA, Daniel Discroll.  In the testimony, Mr. Discoll actually asks Congress to allow the CFTC and the NFA to regulate MORE markets – specifically the off exchange spot metals and energy markets.  While it is commendable that the NFA wants more power to help protect the investors, there are many reasons why this is not a good idea including:

  • The CFTC is underfunded already underfunded (see remarks by Commissioner Gary Gensley, “Specifically, the Commission [CFTC] needs more resources to hire and retain professional staff and develop and maintain technological capabilities as sophisticated as the markets we regulate.”)
  • In 2008 the CFTC was charged with promulgating proposed regulations to require forex managers to register with the CFTC.  This was supposed to be complete by late 2008 – we have yet to see any proposed regulations.  Are we likely to see any quick movements by the CFTC in the spot commodities markets?  Probably not.
  • The CFTC is likely to play a large role in reforming the regulatory framework for the OTC dervitives markets.  See our post on this issue.
  • The NFA, which must be commended for having staff who are generally cheerful and easy to deal with, is nonetheless a slow organization.  Managers who are registered with the CFTC and who have to interact with the NFA face long start-up times because of the overly onerous NFA review requirements.
  • Much of what the NFA does is ineffective – we probably see the most scams from CFTC/NFA regulated entities than we do from SEC/FINRA regulated entities.  Of note was another Ponzi scheme by a CFTC registered FCM, CPO and CTA (see press release).

I am not saying that the CFTC and the NFA should not have the power to regulate these markets.  I am saying that the CFTC and the NFA need to be pursuing the most egregious offenses and that Congress needs to ensure that the CFTC has the funding it needs in order to do its job propoerly.  If Congress does decide to grant jurisdiction over these markets to the CFTC then Congress should also make sure that a funding grant is included in any such rulemaking bill.

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TESTIMONY OF DANIEL A. DRISCOLL
EXECUTIVE VICE PRESIDENT AND CHIEF OPERATING OFFICER
NATIONAL FUTURES ASSOCIATION

BEFORE THE COMMITTEE ON AGRICULTURE, NUTRITION & FORESTRY
UNITED STATES SENATE

JUNE 4, 2009

My name is Daniel Driscoll, and I am Executive Vice President and Chief Operating Officer of National Futures Association. Thank you Chairman Harkin and members of the Committee for this opportunity to appear here today to present our views on closing a regulatory gap that allows fraudsters to sell unregulated OTC derivatives to retail customers.

Since 1982, NFA has been the industry-wide self-regulatory organization for the U.S. futures industry, and in 2002 it extended its regulatory programs to include retail over-the-counter forex contracts. NFA is first and foremost a customer protection organization, and we take our mission very seriously.

Congress is currently expending significant time and resources to deal with systemic risk and to create greater transparency in the OTC derivatives markets. Those are important economic issues, and we support Congress’ efforts to address them. Understandably, most of the debate centers around instruments offered to and traded by large, sophisticated institutions. However, there is a burgeoning OTC derivatives market aimed at unsophisticated retail customers, who are being victimized in a completely unregulated environment.

For years, retail customers that invested in futures had all of the regulatory protections of the Commodity Exchange Act. Their trades were executed on transparent exchanges and cleared by centralized clearing organizations, their brokers had to meet the fitness standards set forth in the Act, and their brokers were regulated by the CFTC and NFA. Today, for too many customers, none of those protections apply. A number of bad court decisions have created loopholes a mile wide, and retail customers are on their own in unregulated, non-transparent OTC futures-type markets.

The main problem stems from a Seventh Circuit Court of Appeals decision in a forex fraud case brought by the CFTC. In the Zelener case, the District court found that retail customers had, in fact, been defrauded but that the CFTC had no jurisdiction because the contracts at issue were not futures, and the Seventh Circuit affirmed that decision. The “rolling spot” contracts in Zelener were marketed to retail customers for purposes of speculation; they were sold on margin; they were routinely rolled over and over and held for long periods of time; and they were regularly offset so that delivery rarely, if ever, occurred. In Zelener, though, the Seventh Circuit ignored these characteristics and based its decision on the terms of the written contract between the dealer and its customers. Because the written contract in Zelener did not include a guaranteed right of offset, the Seventh Circuit ruled that the contracts at issue were not futures. As a result, the CFTC was unable to stop the fraud.

Zelener created the distinct possibility that, through clever draftsmanship, completely unregulated firms and individuals could sell retail customers forex contracts that looked like futures, acted like futures, and were sold like futures and could do so outside the CFTC’s jurisdiction. For a short period of time, Zelener was just a single case addressing this issue. Since 2004, however, various Courts have continued to follow the Seventh Circuit’s approach in Zelener, which caused the CFTC to lose enforcement cases relating to forex fraud.

A year ago, Congress closed the loophole for forex contracts. Unfortunately, the rationale of the Zelener decision is not limited to foreign currency products. Customers trading other commodities-such as gold and silver-are still stuck in an unregulated mine field. It’s time to restore regulatory protections to all retail customers.

Back in 2007, NFA predicted that if Congress plugged the Zelener loophole for forex but left it open for other products, the fraudsters would simply move to Zelener-type contracts in other commodities. That’s just what has happened. We cannot give you exact numbers, of course, because these firms are not registered. Nobody knows how widespread the fraud is, but we are aware of dozens of firms that offer Zelener contracts in metals or energy. Recently, we received a call from a man who had lost over $600,000, substantially all of his savings, investing with one of these firms. We have seen a sharp increase in customer complaints and mounting customer losses involving these products since Congress closed the loophole for forex.

NFA and the exchanges have previously proposed a fix that would close the Zelener loophole for these non-forex products. Our proposal codifies the approach the Ninth Circuit took in CFTC v. Co-Petro, which was the accepted and workable state of the law until Zelener. In particular, our approach would create a statutory presumption that leveraged or margined transactions offered to retail customers are futures contracts unless delivery is made within seven days or the retail customer has a commercial use for the commodity. This presumption is flexible and could be overcome by showing that delivery actually occurred or that the transactions were not primarily marketed to retail customers or were not marketed to those customers as a way to speculate on price movements in the underlying commodity.

This statutory presumption would not affect the interbank currency market dominated by institutional players, nor would it affect regulated instruments like securities and banking products. It would also not apply to those retail forex contracts that are already covered (or exempt) under Section 2(c). It would, however, effectively prohibit leveraged non-forex OTC contracts with retail customers when those contracts are used for price speculation and do not result in delivery.

I should note that NFA’s proposal does not invalidate the 1985 interpretive letter issued by the CFTC’s Office of General Counsel, which Monex International and similar entities rely on when selling gold and silver to their customers. That letter responded to a factual situation where the dealer purchased the physical metals from an unaffiliated bank for the full purchase price and left the metals in the bank’s vault. The dealer then turned around and sold the gold or silver to a customer, who financed the purchase by borrowing money from the bank. Within two to seven days the dealer received the full purchase price and the customer received title to the metals. In these circumstances the metals were actually delivered within seven days, so the transactions would not be futures contracts under NFA’s proposal.

In conclusion, while NFA supports Congress’ efforts to deal with systemic risk and create greater transparency in the OTC markets, Congress should not lose sight of the very real threat to retail customers participating in another segment of these markets. This Committee can play a leading role in protecting customers from the unregulated boiler rooms that are currently taking advantage of the Zelener loophole for metals and energy products. We look forward to further reviewing our proposal with Committee members and staff and working with you in this important endeavor.

Offshore Forex Brokers Race To Fill “Hedging” Gap

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NFA Compliance Rule 2-43 Outlaws Forex “Hedging” For NFA Registered Forex Dealers

(www.hedgefundlawblog.com) The new forex regulations have affected the industry in a number of ways.  Rule 2-43 especially has been a source of ire for some forex managers who have utilized a “hedging strategy” as part of their investment program.  In the forex hedging strategy a trader will have both a long and a short position in a single currency pair.  While these positions are essentially offsetting, some trend following forex traders will hold such positions in order to profit once a trend has been detected.  This strategy was effectively eliminated by the passage of Rule 2-43 for managers trading with forex firms which are registered with the CFTC and NFA Member firms.

This rule provides an opening for offshore forex dealers (who are not NFA Members) to offer this strategy to forex traders.  What you are likely to see, then, is an exodus of trading capital to those brokers which allow hedging strategies (see the two press releases below).  I can think of no clearer example of how regulation is actually forcing capital to go overseas where forex brokers may face lower levels of regulation.  This in turn may actually make forex traders more susceptible to fraudulent practices at the brokerage level (when they trade in countries with less regulation).  Interestingly enough, this movement of money to offshore forex dealers was predicted by the US forex dealers when the rule was announced.

From NFA Release on Compliance Rule 2-43

Although many of the FDMs admit that customers receive no financial benefit by carrying opposite positions, some FDMs believe that if they do not offer the strategy they will lose business to domestic and foreign firms that do.

While some traders may move money to offshore forex dealers, these traders should, however, beware that by trading forex with a non-NFA member firm, they may become subject to state level regulation (and accordingly CFTC registration).  As this is a developing and complex area of law, I always advise forex managers to discuss their business operations with an experienced forex attorney.

Please contact us if you have a question on this issue or if you would like to start a forex hedge fund.  If you would like more information, please see our articles on starting a hedge fund.

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InvestTechFX To Continue Forex HEDGING For Traders After NFA Ruling

InvestTechFX released today that the 1 PIP Forex Corporation will continue to allow all types of hedging after the NFA (National Futures Association) ruling against hedging goes into effect on May 15, 2009. As InvestTechFX is not an NFA regulated broker, it is not obligated to adhere to the NFA’s anti-hedging policies. www.investtechfx.com

Toronto, Canada (PRWEB) April 24, 2009 — InvestTechFX the leading 1 PIP Forex Corp commented on the NFA’s new anti-hedging law (NFA Compliance Rule 2-43 regarding Forex orders) currently scheduled to take effect on May 15th, 2009, and released that the No Dealing Desk Forex broker and Software Solutions Corp will be immune to the new law. InvestTechFX’s industry expert noted that the NFA’s move is not entirely unexpected; the spirit of the new regulation is to protect traders from wasteful over-hedging, but the practical implications of the new regulations will likely be counter-productive. Traders who rely on hedging in their strategies will simply take their business to brokers outside the influence of the NFA, such as InvestTechFX. Ironically, the NFA may put US Forex brokers at a disadvantage by barring them from providing the hedging options that their international competitors will not hesitate to offer.

InvestTechFX the leading 1 PIP Forex Corp welcoming hedging explained that “hedging” generally refers to the practice of taking opposite positions against a previous open position in order to reduce risk. In a broader sense, hedged trading means investing to limit exposure and reduce risk. There are several methods of hedging Forex positions, particularly opening short and long positions within the same currency pair at the same time. This type of hedging will be much more difficult after May 15th, 2009, as the new regulations will put strict limits on such strategies. Positions opened prior to May 15th will not be penalized under the new rule, but all positions opened after the initiation date will be effected. Traders who want to continue hedging while staying with an NFA-regulated broker may now have to open separate accounts for their long positions and short positions; something not all traders can afford to do.

InvestTechFX the leading 1 PIP Forex Corp. welcoming hedging strategies noted that new restrictions on hedging are not the only new regulations set forth in the NFA’s new ruling. After May 15th, 2009, all NFA brokers will have to notify traders in writing prior to adjusting or manipulating trades, with the exception of instances in which the adjustment is favorable to a trader or at a trader’s request. Furthermore, the written notification of intent to adjust must take place within 15 minutes or less of the time of execution. This new regulation (Rule 2-43a) will not be going into effect until June 12th, 2009. In regard to customer orders adjusted because of changes in the price structure of a liquidity provider, written notification must be given to customers prior any initial trading (price increases on the account of transaction clearing must be stated before trading takes place, not after or during trading). InvestTechFX’s analyst explained that these new regulations are likely an attempt to increase cost transparency and reduce the hidden fees that many brokers, particularly market makers, rely upon to limit customer profits. Since market makers must always provide the counterparty for a trade (always buy from a seller and sell to a buyer), there is a strong ulterior motive to undercut customer profits, as customer profits always come at the market maker’s expense.

InvestTechFX the leading 1 PIP Forex Corp. welcoming hedging’s analyst elaborated on the threat of expanding regulation in the Forex market, and the unforeseen consequences that well-meaning regulation agencies can impose upon the market. Forex trading is a fast-growing, highly competitive industry, and because of its inherently global nature, traders are not limited to the Forex providers in their own countries. While many would likely work with a local broker, traders can relatively easily move their business abroad if regulation in their own regions becomes more of a burden than a protection. Government guidelines regarding trading clear policies and risk disclosure can serve to keep the industry legitimate and transparent, but regulating hedging in this way borders on telling traders what strategies they can and can’t use. There is ongoing debate over who the NFA is “protecting” with the new policies, as many of the larger regulatory bodies have a reputation for acting out of the long-term interests of companies instead of retail traders. InvestTechFX’s representative explained that the company could not decisively endorse or condemn the use of mirror position hedging, but did state that the position of InvestTechFX is that the decisions regarding trading strategies should be left to the traders, not the regulators.

InvestTechFX the leading 1 PIP Forex Corporation welcoming hedging is a No Dealing Desk Forex Broker and Federal Canadian Corporation. InvestTechFX offers a 1 PIP fixed spread on 6 major currency pairs, along with a comprehensive account groups system, including interest free, scalping, EA, Micro, and VIP accounts. As a No Dealing Desk, InvestTechFX never takes positions against customers, and has no interest or influence over the trades executed by its customers. www.investtechfx.com

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New Forex Trading Rule by NFA About Hedging Positions Will Change the Trading Game

Forex market is getting revised by continuous trade rule changes. In such uncertain times, Forex Profit Farm may be the perfect solution for people looking to succeed in forex trading.

New York, NY (PRWEB) April 30, 2009 — The forex market is booming with addition of new players every minute because of the high and lucrative potential of making money. Such fast growth poses its own challenges, but at the same time also present with the opportunity to redefine the industry by writing new rules or guidelines.

One such rule that NFA came up with recently is regarding Anti-Hedging. This rule is coming into effect starting 15 may 2009. As per this new law, the trader community cannot create hedged trades.

Rahul Gupta, owner of Forex Profit Farm says, “Currently a forex trader can have two opposite directional trades open at the same time on a single currency pair. So say if you are trading EUR/USD currency pair, you can have short as well as a long trade opened at the same time, which is what is called hedging. The traders do that mostly to judge the direction of the market. Though a hedged open long and short trade on a single currency pair will offset the gain of one position against the other, but when the direction of market trend becomes clear, traders close the losing trade and keep the winning one going. It is a cruel way to trade, but it is very common.”

With that now going to be not possible come May 15, 2009, all traders who use such forex trading practices, will now have to come up with different trading strategies. This is a clear concrete step by NFA to make the forex industry more mature and keep the exponential growth under check.

But Rahul says “Traders who are using best forex trading system don’t have to worry about anything at all. A good trading strategy is independent of such techniques and always remain non-effected from changing rules of similar nature. Traders who use sound trading principles, won’t feel the effect of this new rule at all.”

This is very true because National Future Association (NFA) has passed this new rule to make the unfair practices offered by some of the traders as ineffective, but at the same time preserve the interest of the experienced traders who trade forex for a living.

Like any new rule which is introduced by a governing body, this one also has its share of traders opposing it, but most of the experienced traders see it as a positive step towards regulating the forex trading industry. In such time, a sound trading strategy is all that a trader needs to keep making money by selling one currency against other.

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FINRA to Regulate Member’s Retail Forex Activities

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Comments on Proposed Retail Forex Rules Sought

The Finanacial Industry Regulatory Authority (FINRA) requested comments on a proposed rule to limit the leverage available to retail investors trading in the off-exchange foreign currency (forex) markets.  The proposed rule would be applicable to FINRA member firms and would limit leverage in forex transactions to 1.5 to 1.  The proposed leverage limits are significantly lower than the leverage limits currently offered in the industry (which can reach up to 100 to 1 or higher).  The leverage limitation would not be applicable to eligible contract participants.  The FINRA proposal is the latest step in a series of regulatory tightening measures which have been instituted with the goal of protecting retail investors from the risks of the forex markets (for more information please see New Forex Registration Requirements).  Comments on the proposal are due February 20, 2009.  Continue reading →

NFA Makes Two Separate Announcements on New Forex Rules

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(www.hedgefundlawblog.com) Today the NFA made two separate announcements regarding proposed new forex rules.  The announcements follow a series of similar announcements last week regarding new forex rules (see NFA Continues to Pursue Forex Regulation for Current Forex Dealer Members).  The first announcement dealt with additions to Compliance Rule 2-36 and related Interpretive Notice Changes.  The second announcement dealt with a completely new forex Compliance Rule 2-43.

NFA Proposes Addition to Compliance Rules 2-36 and Related Interpretive Notices – this announcement contained a hodge-podge of different rules the NFA staff felt needed to be addressed.  The announcement centrally focuses on (i) requirement that forex hypothetical results be subject to the anti-fraud provisions of NFA Compliance Rule 2-29(c),* (ii) require FDMs to have an Associated Person file the required weekly reports, (iii) require FDMs to adopt written policies regarding the calculation of rollover interest charges and payments, and (iv) prohibits FDMs from trading a customer’s account when they are a counterparty to the trade.  Continue reading →