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GreenTrader Weblog
GreenTraderTax & GreenTraderFunds
September 6, 2010
EU to discuss bank levy, FTT
A financial-transaction tax proposal is up for debate in the EU this week, and if passed, it could spread to the U.S. too.
An EU-wide bank levy is job number one this week, but there’s also going to be preliminary discussion of an additional bank-related tax. This expanded financial-transaction tax (FTT) won’t be imposed just on currency transactions, but on stocks, bonds and derivatives as well. (For more information, see this WSJ article.)
The EU wants a bank contribution to bailout costs and it is focusing on the bank levy, which would set aside a pound of flesh to cover prior or future bank bailout costs. An FTT isn’t the main issue at hand, which takes some of the pressure off passing it. Many EU countries can object to an FTT, since the bank levy is the main bank contribution to bailout costs. Some finance ministers keep repeating that an FTT won't work on a country-by-country basis; it needs to be passed globally. They’re certainly right because trading will move to non-FTT markets if allowed.
Notice how the CFTC may not allow Americans to get higher leverage offshore with new forex trading rules. (See past blogs and podcasts.) Could regulators and tax authorities use extraterritorial reach on an FTT too?
The bank levy approach focuses on banks and bailouts, whereas an FTT focuses on putting sand in the wheels of speculators in addition to banks. Most FTT sponsors suggest using FTT revenues for social ambitions rather than a bank safety net.
President Obama's proposed $90 billion bank responsibility fee (i.e., bank levy) has dropped off Congressional debate. The Bush tax cuts, other tax extenders and small business packages with job stimulus have taken center stage. Passing any tax-related bills before the November 2010 midterm elections will be difficult. The lame duck session will be tough too. The Republican filibuster seems to be holding for blocking tax increases. Sens. Scott Brown (R-Mass.), Susan Collins (R-Maine) and Olympia Snowe (R-Maine) filibustered Dodd-Frank Fin Reg until Democrats dropped the $19 billion in bank taxes. Perhaps these three Republican Senators might filibuster the President’s $90 billion bank fee proposal too. Bringing the bank fee up for vote in the Senate now is bad politics. Let the EU act first this time, since the U.S. acted first with passing financial regulation (Dodd-Frank).
Global ambition with the FTT reminds me of similar difficulties in negotiating a global climate change treaty (Kyoto and Copenhagen). It's hard to win global consensus, especially during a dangerous and drawn out economic recovery. A global FTT is unlikely to happen anytime soon.
Hopefully, the EU and U.S. will focus on the bank levy — which isn’t necessarily a good idea anyway — and delay an FTT as a separate idea for later debate.
With current miniscule interest yields on government bonds, an FTT is now a more terrible idea than before. Why should an investor pay, say, a 1 percent FTT on both the purchase and sale of a government bond to earn well under 1 percent — the rate on U.S. treasuries now? Would government seek to give itself an exemption again, as it does on paying taxes? (For example, teachers don’t pay state taxes on their fixed pensions.) If you want to completely freeze the movement of money and investments and put a deathblow on stimulating the economies around the world, then keep considering an FTT.
The FTT continues to be a catchall idea for hitting up traders, investors and speculators with unaffordable and excessive government spending programs. Why should important financial market makers and retail investors pay for excessive spending programs? If green energy is so great, then why don’t consumers buy it more? It's like allowing reckless spenders to run up big bills and then forcing their wealthy relatives to pay their debts. That's not fair play.
Political regime change is the best answer. In the upcoming midterm elections, let’s hope the Republican filibuster is solidified with more Republican Senators and Representatives, as Sens. Brown, Collins and Snowe can't be trusted to maintain the current filibuster. Don’t be concerned with Democrats as President Obama can always veto Republican bills. If the U.S. blocks a FTT, then the EU will too.
Can American off-exchange retail forex traders evade strict new CFTC rules by trading on offshore platforms?
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. August 31, 2010
New CFTC forex trading rules call for 50:1 leverage
The CFTC has published its highly anticipated final rules for trading off-exchange retail forex. As discussed on prior blogs, the recently enacted Dodd-Frank Fin Reg bill forced the hand of the CFTC to act by Oct. 19 because it would otherwise bar non-eligible contract participants from off-exchange retail forex trading. The CFTC acted in the nick of time because these new rules are effective on Oct. 18, 2010 — one day before the Dodd-Frank deadline.
Some of the changes are crystal clear — like new 50:1 leverage limits on major forex currencies — but the equally important rule about allowing or barring offshore trading is not yet clear per documents published to date. One off-exchange retail forex broker concluded Tuesday that offshore trading won’t be allowed after the effective date, implying that offshore forex brokers will have to register with the CFTC as well and will be subject to these same new rules.
The CFTC’s new leverage rule calling for a minimum 2 percent deposit on trading major forex currencies off exchange (50:1 leverage) seems on par with what commercial banks like Citi FX Pro offer their retail forex trading customers now.
It’s a wise move by the CFTC to reduce leverage by two times — 100:1 to 50:1 under the new rules — rather than going way over board with its original proposal of 10:1 leverage. Unlike most off-exchange retail forex dealers in the U.S., Citi FX is not regulated by the CFTC; it is subject to bank regulation.
It’s important to note the CFTC grants the NFA powers to set leverage rules higher than these new minimum percentages.
Thankfully, the CFTC responded to the pleas from the off-exchange retail forex trading industry saying the CFTC’s proposed 10:1 leverage rule would put the industry at a huge competitive disadvantage to on-exchange currency futures trading (30:1), commercial bank forex trading (50:1) and offshore off-exchange retail forex trading (200:1). The new deposit rule for non-major currencies is 5 percent (20:1).
Regulators and Congress are often sensitive to chasing business (and fraud) abroad with new rules as well as taking business away from small businesses and handing it over to big banks. The CFTC also wants the U.S. to remain competitive for foreign traders, as foreign traders can continue to trade offshore without concern about registration in the U.S.
It seems these new rules will put a stop to Americans trading retail forex offshore to evade CFTC rules. That trend picked up the pace in recent years and it may need to be reversed quickly. But we aren't completely certain of this yet. We will study the new rules and see if offshore trading remains feasible for Americans under extraterritorial provisions of the Dodd-Frank Fin Reg bill. (We discussed how offshore trading might be a problem for American’s using offshore forex platforms on our recent blog and podcast.)
We base our initial thoughts on the first documents released by the CFTC (links below). In the CFTC’s Q&A document, see the “Who can offer off-exchange forex transactions to retail customers” section. It states that Dodd-Frank Fin Reg changed the definition of allowable financial institutions to “only U.S. financial institutions.” The next section, “What is the scope of the CFTC’s jurisdiction,” implies that unless the entity is regulated by the SEC or bank regulators – again for U.S.-only financial institutions - the default catchall regulator is the CFTC. It makes sense that the CFTC would act in this manner, but again, we aren't certain of these rules yet. Nothing in these CFTC documents specifically exempts offshore forex platforms or brokers from these new rules, either. Stay tuned for further observations.
For more information:
CFTC releases final rules regarding retail forex transactions: Click here.
Final rule regarding retail foreign exchange transactions (summary): Click here.
Federal Register: Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries: Click here.
Questions and answers regarding final retail foreign exchange rule: Click here.
CFTC unveils retail currency-trading rules: Click here.
August 10, 2010
U.S. forex traders may not be able to skirt rules by moving accounts offshore
The Dodd-Frank Fin Reg bill may extend the CFTC's rules for retail forex trading to foreign trading platforms that are also marketed to Americans. This might mean U.S. resident traders won’t be able to evade CFTC rules for the proposed 10:1 leverage and the recent LIFO trading NFA rule change by using a foreign trading platform. Some foreign forex trading platforms offer 200:1 leverage and spread betting (no requirement for LIFO accounting).
The CFTC hasn’t finalized its January 2010 proposed rule changes for "Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries", including a proposed reduction of leverage from 100:1 to 10:1.
A tax and regulatory attorney colleague replied to my questions on these issues: “Our Congress takes a very broad reach of the extraterritorial reach of our securities and commodities regulatory laws. Solicitation of customers who are U.S. persons — even though the solicitation is made outside the U.S. by a non-U.S. person — is covered. That is why, for example, foreign futures exchanges that want to offer their products to U.S. customers must obtain a 30.10 order from the CFTC qualifying them to solicit U.S. customers. As a practical matter, of course, enforcing that extraterritorial jurisdiction can be difficult (is the U.S. going to invade the Cayman Islands?)"
If 10:1 retail forex trading leverage is enacted by the CFTC/NFA, can U.S.-based retail spot forex brokers easily move their U.S. trading customers to their UK affiliates? It seems like the U.S. broker would be switching them to a foreign affiliate to evade U.S. regulations, and based on my colleague's statement, I think it could be a problem.
U.S. forex traders may be left with two unfortunate choices. Trade on CFTC-sanctioned foreign OTC platforms respecting CFTC rules on LIFO and perhaps 10:1 leverage or take their chances in offshore tax havens (reportable on tax returns). Why go to foreign platforms if the rules are the same and perhaps invite more IRS questions? Why go to offshore havens if it’s potentially illegal and a tax problem - with the IRS scrutinizing offshore accounts?
Tax-haven platforms may never get CFTC sanction, so will they be illegal under Dodd-Frank, or, will it be a viable way to navigate around the U.S. forex trading leverage constraints?
Many comments published on the CFTC site say it’s a bad idea to chase U.S. forex trading business to tax and regulatory havens where there’s much more fraud. The way Congress wrote Dodd-Frank, it seems like it's either going to be sanctioned by U.S. regulators or prohibited entirely. Can a U.S. person report forex transactions on their tax return from counterparties that are not sanctioned?
My colleague said Dodd-Frank Section 929Y has one reference to "extraterritorial" (which means ”foreign”) saying the SEC has jurisdiction to regulate extraterritorial swap contracts. We think this same extraterritorial concept may apply to retail forex trading too. The CFTC regulates retail forex, whereas the SEC has authority over swaps. The Dodd-Frank bill couldn’t possibly mention every point, leaving much to interpretation by regulators. We think the CFTC may interpret the legislative text to mean the CFTC has extraterritorial control over retail forex too. It would be too simple for Americans to avoid the new rules with foreign brokers otherwise. If the CFTC has extraterritorial powers on retail forex, then foreign-based brokers will probably not do business with non-eligible contract participants. Good size hedge funds and proprietary trading firms may be qualified participants. Foreign banks and brokers with U.S. affiliates will fear the U.S. regulators attacking their U.S. operations.
Might there be an opening for retail forex trading to move into prop trading firms — with traders joining these firms as partners — inside and outside the U.S.? By combining trading capital with other traders, a group of individuals may achieve eligible contract participant status. There are regulatory problems with prop trading firms too, as covered on this blog.
We’re working on these very important issues for U.S. forex traders. We hope to have more information on our conference call Thursday at 4:15pm ET. We discussed it on last week's podcast too.
Excerpts from the Dodd-Frank bill:
Dodd-Frank SEC. 742. RETAIL COMMODITY TRANSACTIONS.
PROHIBITION-‘(I) IN GENERAL- Except as provided in subclause (II), a person described in subparagraph (B)(i)(II) for which there is a Federal regulatory agency shall not offer to, or enter into with, a person that is not an eligible contract participant, any agreement, contract, or transaction in foreign currency described in subparagraph (B)(i)(I) except pursuant to a rule or regulation of a Federal regulatory agency allowing the agreement, contract, or transaction under such terms and conditions as the Federal regulatory agency shall prescribe.
Dodd-Frank SEC. 929Y. STUDY ON EXTRATERRITORIAL PRIVATE RIGHTS OF ACTION.
(a) In General- The Securities and Exchange Commission of the United States shall solicit public comment and thereafter conduct a study to determine the extent to which private rights of action under the antifraud provisions of the Securities and Exchange Act of 1934 (15 U.S.C. 78u-4) should be extended to cover-
(1) conduct within the United States that constitutes a significant step in the furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors;
(2) conduct occurring outside the United States that has a foreseeable substantial effect within the United States.
(b) Contents- The study shall consider and analyze, among other things--
(1) the scope of such a private right of action, including whether it should extend to all private actors or whether it should be more limited to extend just to institutional investors or otherwise;
(2) what implications such a private right of action would have on international comity;
(3) the economic costs and benefits of extending a private right of action for transnational securities frauds; and
(4) whether a narrower extraterritorial standard should be adopted.
(c) Report- A report of the study shall be submitted and recommendations made to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House not later than 18 months after the date of enactment of this Act. August 7, 2010
Dodd-Frank bill seeks to crack down on forex arena
Congress took a new approach with the CFTC in the Dodd-Frank bill. The CFTC was dragging its feet on Congress's CFTC Reauthorization Act of 2008 (part of the Farm Bill) calling for forex regulation, which had been mostly overlooked by regulators for decades. With Dodd-Frank, retail forex trading will become illegal for non-eligible contract participants (most retail traders) unless the CFTC finishes its new forex regulations in short order (Dodd-Frank Bill Section 742(c)). The comment period on the CFTC proposals published in January expired and I expect rules to be published soon.
We imagine the CFTC will drastically reduce allowable forex leverage from existing 100:1 to a significantly lower amount, but perhaps not as far as its proposed rule change of 10:1 leverage. Will American forex traders be able to continue using foreign trading platforms to escape the reach of Fin Reg and the CFTC (including these new rules)? You can follow the progress of these regulatory changes here. Also, see the WSJ article "Financial Bill Could Set The Stage For Uneven Retail Forex Rules" dated July 30, 2010.
Dodd-Frank Section 742(c) has two areas of concern. It updates the Commodity Exchange Act (CEA) Section 2(c)(2)(D) Spot Commodities (Metals) and Section 2(c)(2)(E) Spot Forex. Google these sections to learn more.
Prop-trading update
Goldman Sachs told one of the largest prop-trading firms to change its payouts to prop traders to 80 percent or less, down from 100 percent. FINRA Regulatory Notice 10-18 said that 100 percent payouts were indicative of “beneficial owners” (disguised customer accounts and these firms are not registered customer-account broker dealers). Goldman seems to be closely following all rules now to stay out of trouble with the SEC. (Click here for the background on this issue.)
These hot topics, along with those listed below, are covered in this week's podcast. Click here to listen.
Q&A:
Trader tax status, mark-to-market accounting and entities.
Update on the SE tax loophole for investment managers. Recent Republican filibusters blocked repeal of this tax loophole from current jobs and tax extender bills. Green explains how investment managers use S-Corps to reduce SE tax. He further explains how it's the reverse effect for traders.
Should prop traders join prop trading LLC-firms as an entity member or as an individual? Green points out how using an entity can be better for legal protection and better for tax reasons too - unlocking the opportunity for AGI deductions (retirement and health insurance premiums).
Foreign trading to escape Fin Reg and tax implications.
Commentary from Green sprinkled in to Q&A.
Brent Gillett on new English-version Form ADVs.