Can American off-exchange retail forex traders evade strict new CFTC rules by trading on offshore platforms?
September 1, 2010
Congress and regulators have thrown the forex trading industry a huge curve ball and we are all scurrying to get answers to important questions.
Many questions remain regarding trading offshore to evade leverage and other constraints posed by the new CFTC rules. Today we try to answer a few more questions along these lines. The answers are still unclear, and we await new NFA guidance, which was promised to one forex dealer executive. A forex dealer executive told me the NFA may actually be waiting on the CFTC regarding the overseas issue, and he expects it will take more than a few days. The overseas firestorm is probably underway.
According to one leading forex broker executive, the CFTC author of these new retail forex trading rules said the Dodd-Frank (DF) change classifying financial institutions (FI) as "U.S. only" (see CFTC Q&A "who can offer.." section) won't be made for 360 days from DF enactment (7/21/10). This gives EU banks offering forex trading to U.S. customers time to register in the U.S. But I think FI refers to banks and not CFTC-registered FCMs, which probably include the FDMs (forex-dealer merchants, the prior designation) too. The DF list has FI, SEC-registered and CFTC-registered companies, plus insurance companies and more. FI and FCM seem to be different categories.
So if this forex broker says its U.S. retail forex traders using offshore platforms from its affiliates have more time to close accounts, that may not be true in my view. If the foreign account is deemed a foreign affiliate of an existing CFTC-registered FDM, then using the 360-day extension seems inappropriate to me for financial institutions. If it's a foreign institution such as an EU bank with no U.S. CFTC-registered FCM or FDM registrations, then maybe it’s okay to use the 360-day extension.
Hopefully the NFA and/or CFTC will clarify this important issue soon. There are plenty of people asking these important questions, as thousands of Americans have offshore retail forex trading accounts.
It makes sense to me that DF gives 360 days to foreign institutions to form U.S. affiliates if desired. To spring a prohibition on foreign financial institutions offering forex trading to U.S. customers as of Oct. 18, 2010 (the effective date of the new CFTC rules) would be extremely undiplomatic on a global country-by-country dealing basis. There may be lawsuits and diplomatic requests made and this takes plenty of time to deal with properly.
This type of financial transaction/trading protectionism is rearing its ugly head on several international stages already. The U.S. is upset about EU rules and proposed rules requiring U.S.-based investment advisers to register in the EU for a required "passport" to raise money from EU investors. This is a huge problem for the U.S.-based investment-management industry. EU banks are upset about new U.S. “FATCA” tax rules requiring EU banks to report to the IRS U.S. customers in their ranks. FATCA ties in with this FI U.S.-only forex trading rule too, as it can help enforce it.
According to the forex dealer executive I spoke with, the NFA plans to issue a notice to members perhaps today or in a few days to clarify DF and the new CFTC retail forex trading rules, mostly for implementation issues. This expected notice may not speak to the foreign trading issues, although hopefully it will.
One big implementation issue is how currently CFTC-registered FDMs (under CRA) go about converting their registrations to the new DF-category of RFED. Will this be automatic? How can FDMs make many changes in their registration by Oct. 18, the implementation date for the new CFTC rules?
This executive said many U.S. forex dealers currently use offshore platforms and affiliates for segregation of funds in the UK for asset protection purposes. He said if a person files for bankruptcy in the U.S., their UK forex trading account capital and rights are protected from U.S. bankruptcy courts. Leverage is unlimited in the UK, but usually 100:1. U.S. customers avoid the NFA's controversial hedging rule when trading in the UK. He said capital isn't a big issue because many U.S. forex dealers can absorb more U.S. customers to repatriate from the UK and other international affiliates. I presume leading forex dealers can move UK capital back to U.S. too as needed. This executive says non-residents (international business) may want to stay in the UK since the U.S. leverage is lowered to 50:1. He said U.S. platforms can handle things. The biggest concern is upsetting some U.S. clients who already set up foreign-based accounts and now may have to redo all the paper work back into the U.S.
U.S. FDMs in the forex dealer coalition are fine on these new rules per this executive. Most are already registered as FDMs and compliant with the NFA, and 50:1 leverage is reasonable in their view. They expect the RFED change to be fairly easy to accomplish.
I see a big problem for foreign forex dealers operating from tax havens. Most don't have U.S. operations or branches and they won't want to register in the U.S. Registration for foreign companies probably requires a U.S. operation, subsidiary or branch office designation. Branch office taxes can lead to trouble on Section 482 transfer pricing tax issues (where the profits are booked). If the IRS finds trouble with tax haven cheating, it can pounce on these institutions. Therefore, I presume many tax-haven forex dealers may lose forex trading business to CFTC-registered RFEDs who will be happy to win back this business.
Forex IB (Introducing Broker) CFTC-registration changes are important too. The final rules are better than expected from the proposed rules. With final rules, a forex IB can simply register with the NFA on its own in the same manner as futures IBs do now. They don't need that troublesome (proposed rule) guarantee from an FDM, although they have that choice too. Few FDMs want to take that kind of risk or tie up their capital by guaranteeing a forex IB.
There are many characters in the forex industry that inappropriately blur the lines between education, investment advice, money management and other related services. Many of these forex players may be drawn into registration in some capacity with the NFA and CFTC, perhaps as an IB, and many will want to avoid that registration for many different reasons. Some may have trouble passing NFA back ground checks. Others don't want the NFA oversight over their perhaps fraudulent or inappropriate business models. Many don't want to be burdened with other rules like disclosure and reporting. Many will surely have trouble with the conflicts of interest rules too.
My colleague Brent Gillett, JD and his associate at the Investment Law Group wrote an article on these rule changes. It includes a nice history of regulation (or lack thereof) of off-exchange retail forex, the new registration categories and how it works. It's a good primer on the subject.
The attorney and author of this article said to me via email: I spoke with an attorney at the CFTC Monday who is dealing with these rules. His interpretation was that because of the change to the CEA by Dodd-Frank from "financial institution" to “U.S. financial institution”, overseas forex intermediaries that are not registered as FCMs or RFEDs will not be able to serve as counterparty to U.S.-based retail investors with respect to OTC forex transactions. This would apply to futures and options and futures “look alike” contracts. I say that the enforcement issues are unresolved in our article both because of the practical realities involved in enforcing this rule and because this was just an opinion of one regulator, not of the Agency.
Excellent comment on our FaceBook page:
Robert: I spoke with both the NFA and the CFTC by phone. The most knowledgeable was a guy in the compliance dept at the CFTC. He says the rules apply to any brokerage, foreign or domestic, that wants to do business with U.S. traders. So, while the regulations are not aimed at traders themselves, they are indeed aimed at any/all brokers that do business with U.S. traders. In other words, if we have accounts at FXCM UK or Dukascopy (Switzerland) or anywhere else in the world, the CFTC will force those brokers to change our leverage to 50:1. The only good news I heard was the definition of what the "major currencies" are. Apparently the NFA has a list of what it considers the major currencies. This is in the Financial Regulations section of the NFA manual. The link is here: http://www.nfa.futures.org/nfamanual/NFAManual.aspx?RuleID=SECTION+12&Section=7 . Fortunately this includes (in addition to USD) the EUR, GBP, JPY, CHF, CAD, AUD, NZD and even the Norwegian, Swedish and Danish currencies. In other words, any currency that retail traders are likely to trade will be at 50:1 not 20:1. I can live with that. I'm not happy about the excessive intrusion of our government into our business, but I can live with this.
See our Sept. 2 podcast for more on this topic.
Posted 2 years, 11 months ago on September 1, 2010
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