FXDC Firms Comment on Guaranteed IB Proposal

FXCM, FX Solutions, Interbank FX, and OANDA Provide Feedback on CFTC Forex Proposal’s New Guaranteed Introducing Broker (IB) Rule

The new CFTC Forex Proposal contains a proposed requirement for all introducing brokers (IBs) to be guaranteed by one futures commission merchant (FCM).  Prior to the proposition of these rules, IBs were allowed to be either independent or guaranteed.  To be independent, an IB had to meet a minimum capital amount of $45,000, among other financial requirements. To be guaranteed, an IB did not have to meet a minimum capital amount but instead had to sign a guarantee agreement with an FCM stating that the IB agrees to introduce all clients to that broker only.

I’ve read through many (although nowhere near all) of the public comments to the new Proposal listed on CFTC’s website but have not found many comments on this issue. This can be attributed to the overwhelming focus on the 10-to-1 leverage proposal which those involved in Forex strongly oppose.

In order to gain some sense of the reaction to the guaranteed IB proposal, I decided to contact the firms associated with the Forex Dealers Coalition (FXDC), an alliance of the top U.S. forex firms, who have come together to advocate against aspects of the Proposal, specifically the proposed 10-to-1 leverage. The firms that currently form FXDC are: GFT, Oanda, IBFX, Gain Capital, FXCM, FX Solutions, FXDD, PFG Best, CMS Forex, and Alpari US.

I called each firm and heard back from four of them. Here is a brief overview of what each firm had to say:

The following outlines the questions I asked them regarding the guaranteed introducing broker proposal and the firms’ feedback in full.

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Questions

1) What is your firm’s opinion on the proposal that all Introducing Brokers (IBs) be guaranteed?  What affect would this change have? How important of an issue is this for your Firm and for the Forex community in general?

2) Under proposed rule 5.5 of the Proposal, IBs (along with FCMs and RFEDs) would be required to have their clients sign risk disclosure statements. What is your firm’s opinion on this?

FXCM

I spoke on the phone with Jaclyn Sales, FXCM’s spokesperson. When I asked her about FXCM’s opinion on the guaranteed IB proposal, Ms. Sales replied,

FXCM’s main focus is the 10 to 1 proposed leverage change and we don’t want to distract from this core issue by commenting on the other issues at this time. FXCM has offices around the world and is regulated in seven jurisdictions. We [FXCM] can’t worry about anything but 10-to-1 leverage rule.

To emphasize the strength of the opposition toward the new leverage requirements and the unprecedented amounts of comments that the CFTC received concerning this issue, FXCM sent me this statement:

To show just how unprecedented these comments coming into CFTC are, last year the CFTC published some 17 rule proposals in the federal register.  The number of comment letters for all these proposals COMBINED was only 220.  In 2007 & 2008 total comments for all CFTC register proposals totaled less than 250.  This year the CFTC also released another rule proposal, regarding energy speculation limits.  That issue has far more importance to the national economy than our small issue.  Yet only 22 people have bothered to comment on those limits.  Meanwhile, nearly 7,000 comments have poured in our issue. It is truly unprecedented.

FX SOLUTIONS

I received an email from Raymond Carmichael, whose firm handles PR for FX Solution, who had this to say:

At this time they [FX Solutions] are not making any public statements on the IB guarantee issue.

The following is a press release from FX Solutions in response to CFTC’s proposal:

Saddle River, NJ, January 27, 2010 – FX Solutions is pleased that the CFTC (Commodity Futures Trading Commission) is proposing increasing regulation for the U.S. Retail OTC Forex Market with the goal of increasing transparency and eliminating fraud. FX Solutions is a proud registrant of the CFTC and member of the NFA and will continue to cooperate with both regulatory bodies in their efforts to put an end to fraudulent practices. However, it is our opinion that if the proposed measures are too severe they will prove counterproductive. The current proposals call for, amongst other things, a reduction in client trading leverage from the current 100:1 to 10:1, even on the world’s most widely traded and liquid currency pairs. FX Solutions is opposed to this change and is actively lobbying against it. We are currently working with the other Forex Dealer Members (FDMs) as part of the Foreign Exchange Dealers Coalition (FXDC) (http://fxdc.org/) to provide a unified industry voice to lobby both Congress and the CFTC.

Michael Cairns, CEO of FX Solutions, offered, “We welcome the call for increased transparency and regulation of the OTC Forex market. We, as a Company, have worked hard over the years to achieve an exceptional regulatory record through strict compliance with NFA and CFTC regulations and U.S. law. It is our belief, however, that if these current proposals are enacted into law they will cause a mass exodus of trading to other, less stringent, international locations where clients are free to choose the leverage and trading strategies that match their individual and unique tolerance for risk. If the clients leave then it will only be a matter of time before the regulated Forex companies follow. What will be left is a void that will be filled by exactly what the CFTC is trying to prevent, unregulated companies seeking to deceive an unsuspecting U.S. public. A reduction in leverage will not combat fraud and deception.”

Interbank FX

The following is what Todd Crosland, Chairman and President of Interbank FX, had to say regarding the matter:

First and foremost, it is important to note that in our opinion, the practice of guaranteeing IBs in the Forex industry to date is a relatively unpopular one.  Without performing any research we cannot be sure as to the validity of our opinion, however, we believe that very few FDMs, if any, currently guarantee any of their IBs.  As such, it will be interesting to see how this rule will affect the industry if it is accepted.

The CFTC rule proposal, taken directly from the Federal Register states, “In addition, the proposal would require any IB that introduces retail forex transactions to an RFED or FCM to be guaranteed by that RFED or FCM.”  This will likely affect IBs in a couple of different ways.

The First, which is seen as a potentially positive effect for many current or potential IBs, is that the rule proposal also states, “An IB that is guaranteed by an FCM or RFED will not be subject to the minimum capital requirements set forth in Regulation 1.17(a)(1)(iii).”  This may be seen as a favorable rule proposal for some independent IBs who normally would have to allocate a significant amount of money to be set aside as reserved net capital.  Additionally, this may make it easier for individuals or firms who have wished to become registered as an IB but have not had the necessary capital to do so as an independent IB.

On the contrary, this rule requiring an IB to be guaranteed by an RFED or FCM is seen by some to be potentially damaging as well.  For one, if this portion of the rule passes, RFEDs will become more directly responsible for the actions of their IBs from a regulatory standpoint (as is the case in the guarantee relationship).  Normally, FCMs have a somewhat limited responsibility for supervising the dealings of their IBs and therefore a very limited liability to the actions of their IBs.  This may force RFEDs to apply more resources to the supervision of their IBs, and may persuade many RFEDs to be very limited in choosing the IBs they guarantee, or may actually cause RFEDs to completely abandon the IB channel.  The resulting effect of this is that IBs will have a difficult time finding RFEDs who are willing to guarantee them.

On a net basis consideration, most argue that this will help the typical IB with alleviating a bit of their financial burden, however will most likely have the effect of shrinking (or possibly consolidating) the entire IB channel of the forex industry.

OANDA

I had the opportunity to speak with Michael Stumm, CEO and President of OANDA, who offered me the following comment:

The introducing broker (IB) practice is ‘unkosher’. 10 to 20 years ago, IBs played a more important role. They acted as advisers who helped clients. Today, they add no value at all—they just try to maximize their revenues. The IB process is non-transparent. An IB should sent clients to the best firm—the firm that is best suited for the client. But in practice, IBs send clients to the firm that pays the IB the most money. Another problem regarding IBs is remuneration. A lot of IBs get paid a percentage of the volume traded by clients, but clients often have to pay a higher price to their futures commission merchants (FCMs) as a result of the IB’s referral. This is unethical—FCMs should be more transparent about how much money they are paying out to the IB.

The new proposal for IBs to be guaranteed instead of independent doesn’t matter; we [Oanda] do not like the practice of IBs altogether. Furthermore, IBs are independent by nature—it will be very difficult to mandate that all IBs be guaranteed. IBs are independent parties. It would not be reasonable for FCMs to guarantee IBs.

Although we find the practice abhorrent, we will say that it is a good thing that the CFTC is proposing registration requirements for IBs.

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Other forex law blog articles include:

Bart Mallon, Esq. of Mallon P.C. runs the Forex Law Blog and provides forex registration service through www.forexregistration.com. Mr. Mallon also runs the Hedge Fund Law Blog. He can be reached directly at 415-868-5345.

March 20, 2010 | Filed Under forex registration

 

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