Dodd-Frank act and July 15th Deadline

July 15th 2011 is a big day for forex brokers as well as binary options brokers across the world. Exactly one year ago, on July 15th 2010, the Senate passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).

On July 21, 2010, President Obama signed into law the “Dodd-Frank Wall Street Reform Act” (the “Dodd-Frank Act” or “Act”). The Dodd-Frank Act most likely will bring about sweeping regulatory changes within the financial services industry. However, at over 2,300 pages in length, few people have read this legislation in its entirety. Of those individuals who have read the Act, few can comprehend the implications of such sweeping reform.

This act/regulation will significantly change the structure of US based over-the-counter derivaties markets. The regulation aims to promote a higher level of transparency and to monitor and moderate systematic risks.

Key features of the Dodd-Frank Act

OTC derivatives market participants, especially retail forex brokers and market participants will be subject to CFTC (commodities futures trading commission) including the SEC (securities exchange commission) registration and regulation.

Financial services firms will be required to centrally clear or trade on exchanges standardized OTC derivatives that are mandated to be cleared by the CFTC/SEC and accepted by a regulated clearing agency.

Firms engaged in dealing in CFTC regulated over-the-counter products must register as swap dealers where as firms engaged in dealing with SEC regulated over-the-counter products must register as a securities based swaps dealers. New derivatives products must be submitted to the SEO or the CFTC for approval, classification and jurisdiction determination.

Under the rules, certain parties engaging in the retail foreign exchange business must register with the CFTC. These include counterparties offering retail foreign currency contracts as either futures commission merchants (FCMs) or retail foreign exchange dealers (RFEDs, a new category of registrant). In addition, persons who solicit orders, exercise discretionary trading authority or operate pools with respect to retail foreign exchange transactions will be required to register, either as introducing brokers, commodity trading advisors, commodity pool operators or as associated persons of such entities (other than those that are otherwise exempt). However, “otherwise regulated” entities, such as United States financial institutions and SEC-registered brokers or dealers, will continue to be able to serve as counterparties in retail foreign exchange transactions

Dodd-Frank Act & US based forex brokers

As a result of the recently enacted Dodd–Frank Wall Street Reform and Consumer Protection Act, U.S.-based retail forex dealers such as OANDA, Forex.com are prohibited from offering leveraged trading in precious metals to retail clients after Friday, July 15, 2011.

The Dodd-Frank Act imposes the following rules

  • 50:1 Leverage on most FX pairs
  • Trading limitations (No Hedging, FIFO rule)
  • 20:1 Leverage on FX Exotics
  • No Spot Gold + Silver
  • No Foreign Banks or Off Shore FX Brokers

Effective 90 days from its inception, the Dodd-Frank Act bans most retail OTC forex transactions. Section 742(c) of the Act states as follows:

“…A person [which includes companies] 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 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…”

This provision will not come into effect, however, if the CFTC or another eligible federal body issues guidelines relating to the regulation of foreign currency within 90 days of its enactment. Registrants and the public are currently being encouraged by the CFTC to provide insight into how the Act should be enforced. See CFTC Rulemakings regarding OTC Derivatives located at the following website address [1], under Section XX – Foreign Currency (Retail Off Exchange). As this provision is potentially devastating to the forex industry, affected readers are encouraged to voice their opinions to the CFTC directly. To do so commentary should be forwarded to via email to: Secretary@cftc.gov

Attn: David A. Stawick, Secretary
Commodity Futures Trading Commission
Three Lafayette Center
1155 21st Street, NW
Washington, DC 20581

It is essential that OTC forex participants seek professional help to discuss possible operational and regulatory contingency plans.

A retail foreign exchange transaction is one between an eligible counter-party and a retail customer.3 Generally, retail customers are:

  • Individuals with less than $10 million in total assets, or less than $5 million in total assets if entering into the transaction to manage risk, and who are not registered as futures or securities professionals;
  • Companies, other than financial institutions and investment companies, with less than $10 million in total assets, or a net worth less than $1 million if entering into the transaction in connection with the conduct of their businesses; and
  • Commodity pools that have less than $5 million in total assets.

Dodd-Frank Act & Introducing Brokers in the US

The final rules also differ from the proposed rules with respect to persons registering as introducing brokers. Under the final rules, introducing brokers may choose either to meet the minimum net capital requirement applicable to introducing brokers for futures and commodities options, or be guaranteed by an FCM or RFED (the proposed rules had required that introducing brokers be guaranteed by an FCM or RFED).

Summary

  • Elimination of OTC Forex: Effective 90 days from its inception, the Dodd-Frank Act bans most retail OTC forex transactions as per section 742(C) of the Dodd-Frank Act.
  • Elimination of OTC Metals:As for OTC precious metals such as gold or silver, Section 742(a) of the Act prohibits any person [which again includes companies]from entering into, or offering to enter into, a transaction in any commodity with a person that is not an eligible contract participant or an eligible commercial entity, on a leveraged or margined basis.
  • Small Pool Exemption (Introducing Brokers) Eliminated: Pursuant to Section 403 of Act, the “privateadviser” exemption, namelySection 203(b)(3) of the Investment Advisers Act of 1940 (“Advisers Act”), will be eliminated within one year of the Act’s effective date (July 21, 2011).
  • Alteration to financial qualifications: Section 413(a) of the Act alters the financial qualifications of who can be considered an accredited investor, and thus a qualified as eligible participant (“QEP”). It is important to note that the revised accredited investor standard only applies to new investors and does not cover existing investors. However, additional subscriptions from existing investors are generally treated as requiring confirmation of continuing investor eligibility.

What should US based/resident traders do?

Most financial institutions have already informed their US clients about the implications of the Dodd-Frank act. However, if you still in the blue, contact your forex broker in regards to the Dodd-Frank act and make arrangements to withdraw your funds.

What should Non US based/resident traders do?

Retail OTC forex and binary options services continue as normal.