On Monday, the CFTC will issue its decision on leverage caps in the forex punting business. It’s a make or break moment for all those firms that offer margin trading to those wanting to play currency pairs.
After a shockingly long period of regulatory inaction, the CFTC suddenly popped up two months ago and proposed a 10-to-1 cap on leverage for retail transactions. The move came as something as a surprise to those firms offering up to 200 times leverage for a “client” trading, say, the dollar-yen.
A huge lobbying campaign has been waged since then, playing the patriot card (‘thousands of US jobs are at risk’) and warning that the whole retail forex industry will move “offshore” (i.e. to Britain) if the cap is imposed.
The argument here is that a 10/1 cap on leverage would remove much of the potential upside reward which draws retail forex punters in the first place. So the CFTC risks either killing a fun, profitable industry, or driving it into the arms of a competing financial centre.
But the lobbying effort has been hampered by the fact that there are both white hats and black hats in the world of FX broking, along with a whole load of grey hats.
At one end of the scale, we have firms like OANDA, who might genuinely be considered to be offering a beneficial services to their clients. This is a pure technical platform, shorn of aggressive sales teams or garish publicity, and which typically offers clients maximum leverage of 50/1.
Then there are the black hats – those firms offering leverage of 100/1 or more and who are effectively churning their client base every few months.
Here’s how the hustle works:
Retail punters put up $5,000 and, at 200/1, they are suddenly able to trade 10 regular forex lots, with a notional value of $1m. Normal market volatility will soon require the punter to put up further margin; even the smallest bout of abnormal volatility will wipe the retail punter out.
Compulsory stop-losses are commonplace and these are quickly triggered by any spike in the price of the currency being played.
What’s more, the punter’s counterparty is usually the forex “broker,” who might also be quote supplier…
You can see where we are going here. Suffice to say, forex brokers at the wilder end of the scale are in the business of shaking down their customers, typically for $5,000 apiece.
The punters themselves are convinced that they are simply gambling, that they could win big, and that forex trading is, say, better than playing roulette.
But there’s a big difference: casinos are properly regulated and the punters know the odds. That’s not the case in the retail forex business. Yet.
Enter the CFTC. January’s proposals signaled the introduction of all the traditional aspects of financial regulation – broker registration, disclosure, record keeping, financial reporting, minimum capital requirements and various other operational standards. And that 10/1 leverage cap…
Whether the CFTC is determined to impose this across-the-board curb is unclear. Whatever hat they wear, brokers are probably right to argue that business will migrate to the UK and elsewhere if trading is extinguished in this way.
But Michael Stumm at OANDA has a compromise. As he put it to FT Alphaville, the CFTC should copy what the Canadian regulators do.
IIROC, the Canadian regulatory body, insists that leverage is tailored to the risk and liquidity of each particular currency pair being traded. The leverage cap comes out at a little over 30 for most popular pairs and is updated monthly, depending on market conditions.
Stumm points out that this approach takes market volatility into account, which is the critical matter here.
In fact, the CFTC could go one step further. It could adopt the Canadian leverage model and then invite the UK’s FSA to follow suit.
Think about the PR opportunity: cross-border, transatlantic, joined-up regulation, in support of ordinary people using the financial markets.
The $100bn FX hustle – FT Alphaville