| 20 January 2010

A total of nine currency dealers, including Gain Capital, GFT Forex, FXCM, Interbank FX and Oanda have joined forces to fight the hedging rule changes proposed by the Commodity Futures Trading Commission (CFTC). The Foreign Exchange Dealers Coalition, or FXDC, issued a letter last week outlining why the firms feel a change to the hedging rules would be a "crippling blow" to the industry.

"Should the 10 to 1 leverage rule be adopted the vast majority of those accounts can be expected to go offshore," the letter points out. The firms put the domestic industry's revenue at over $1 billion and claim that the industry employs "thousands of people" that would all be at risk should the proposed rules go into effect.

Domestic firms and international firms both currently offer 100 to 1 leverage. The proposed rules would diminish the leverage domestic firms could offer to a maximum of 10 to 1. Key to the FXDC's argument is this idea that a vast majority of the U.S.-based accounts will head offshore to seek greater leverage. The coalition is particularly concerned about losing acounts to foreign, unregulated forex dealers. "These unregulated forex dealers don’t have to worry about capital requirements, risk management models, marketing ethics, dealing practices or even returning a customer’s funds," said the group in the letter.

While we understand the problem and agree that most accounts would probably head off shore, we thought it best to understand the problem more completely. After all, it is possible that there are a few legitimate foreign dealers that simply compete well in the marketplace. Trade, tarrifs and regulations are not new fights for U.S. businesses when competing with international counterparts. But we always expect U.S. firms to be held to the highest possible standard and want to better understand the problem. 

So we thought it would be interesting to dig in on the issue of leverage without regard to the business impact. In other words, if international competition weren't the issue, why should 100:1 leverage remain unchanged?

We put this question to Todd Crossland, Chariman and President of Interbank FX. “Higher leverage amounts are certainly not required in order to place a forex trade," he told us. "However, it should be a customer’s right to choose the leverage level they wish to trade with based on their individual risk tolerance and trading goals.” 

Adding more clarity to the issue he said, “Limiting leverage also limits individuals’ access to the market.  People with small trade accounts will not be able to enter into positions and have enough equity to withstand market fluctuation.”

Charlie Delano, Director of Government Affairs at FXCM, echoed these sentiments. He told us that, "many experienced traders use [100:1] leverage as part of their trading strategy and it is crucial to their profitability.  10:1 leverage would dramatically deplete a customer’s capital thus hampering their ability to trade and profit from the modest movements that take place in the currency market."

To be fair, it does seem that the regulators are struggling with the issue a bit, and perhaps the dealers are now trying to capitalize on that confusion. Mr. Delano was quick to point out that the CFTC itself is being inconsistent with its policies. "Just a few months ago the CFTC endorsed the NFA’s rule that set leverage at 100:1," he told us. (See the NFA notice here.)  

This latest reversal came "as a complete surprise to the industry," said Mr. Delano. "Retail forex traders are not crying out for leverage restrictions. On the contrary, the response to this rule so far from our customers is outrage and dismay."

Retail traders may not be crying out for changes, but the regulators that oversee the industry see things differently. From the regulator's perspective, the changes are necessary, regardless of the impact. The CFTC said the rules are coming in response to "a number of improper practices that have raised concern, among them solicitation fraud, a lack of transparency in the pricing and execution of transactions, unresponsiveness to customer complaints and the targeting of unsophisticated, elderly, low-net-worth and other vulnerable individuals," according to the Wall Street Journal.

Wherever you may stand on this issue one thing is certain: as more and more retail investors flood the forex market, change will come to the industry; but it won't come easy. Both sides, it seems, are preparing to stand their ground.