Many retail forex traders have complained that the CFTC’s new regulations on leverage, counterparties, and hedging will constrain their ability to trade forex profitably. However, critics of the new regulations will be happy to know that October 18th, 2010 does not quite mark the end of the prior era of minimal regulation. This is because October 18th marks the deadline for registration as a Futures Commission Merchant (FCM) or Retail Foreign Exchange Dealer (RFED) but not for certain other counterparties. Entities that do not fall within the CFTC’s jurisdiction will have to look to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) and to the rulemaking schedule of such entities’ primary U.S. regulator to determine how they must rework their activities with regard to off-exchange retail forex transactions. Foreign banks, many of which offer forex platforms to U.S. investors, will be prohibited counterparties because of language in Dodd-Frank Section 742. However, this provision does not become effective until July 16, 2011. While Congress did not leave room for bank regulators to make rules that would allow foreign banks to intermediate forex transactions for U.S. retail investors after July 2011, these foreign banks are still outside of the CFTC’s jurisdiction and, thus, unaffected by the CFTC’s final regulations on OTC retail forex. Therefore, a U.S. retail trader could continue to trade forex through a foreign bank, with no leverage or hedging restrictions, until July 16, 2011 without running afoul of any of the new rules that have received so much attention. A similar analysis can be applied to broker-dealers and financial holding companies. Broker-dealers and financial holding companies are among the specifically enumerated counterparties in the Commodity Exchange Act, eligible to intermediate OTC forex transactions for U.S. retail investors. However, like foreign banks, these entities are not within the CFTC’s jurisdiction and thus, are not subject to the CFTC’s final regulations on OTC forex. Unlike with foreign banks, Congress did leave room for regulators to draft rules on off-exchange retail forex with respect to broker-dealers and financial holding companies. Dodd-Frank gives the SEC and bank regulators, that regulate B-Ds and financial holding companies, respectively, until July 16, 2011 to adopt rules to regulate OTC retail forex futures and options (including options on futures). If these regulators do not adopt rules within this time frame then B-Ds and financial holding companies will be prohibited from acting as counterparty to U.S. retail investors with respect to the above-mentioned forex contracts unless such entities register as an FCM or RFED. Thus, a U.S. retail trader could continue to trade forex through a broker-dealer or financial holding company until July 2011 without regard to the CFTCs new leverage and hedging restrictions. What happens after July 2011 will depend on what action, if any, the SEC and bank regulators take over the next 9 months. It is not clear what will happen to futures look alike contracts which many traders and counterparties call spot transactions after July 2011 because the prohibition in Dodd-Frank only addresses futures and options (and options on futures). Clearly, futures “look alike” contracts executed through an FCM or RFED will be subject to the CFTC’s final regulations on off-exchange forex after October 18th, 2010. However, a plain language reading of Dodd-Frank suggests that U.S. financial institutions, broker-dealers and financial holding companies could continue to intermediate futures “look alike” contracts after July 2011 even if the SEC and bank regulators fail to adopt rules to regulate this activity. We will continue to monitor this issue and will share any developments as we become aware of them.
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