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Forex Regulation in the USA: Protecting the Financial Interests of the Little Guy and the Establishment

Not so long ago it used to be that a forex broker operating in the US did not need to be regulated by any agency. For some it was a good thing that represented more freedom and innovation than any other industry; for others it was the "wild west" of trading, with unregulated forex firms representing a mix of good, bad and ugly. However, since the passing of the 2008 Farm Bill and later the Dodd-Franc Wallstreet Reform Act of 2010, the entire FX industry was given a complete overhaul. Now the NFA (National Futures Association) and CFTC (Commodity Futures Trading Commission) are obligatory regulating organizations for the Forex brokers that are based in United States or want to legally deal with the U.S. residents.

The biggest change brought forth by the 2008 Farm Bill was the requirement for all retail forex brokers and introducing brokers to be regulated AND meet specific capital requirements. According to the bill, retail forex brokers will need to increase their capital by $20 million beginning 360 days after the enactment. Introducing brokers likewise need a sizable capital requirement or need to be vouched for by the retail forex firm. Consequently, many smaller retail forex brokers and introducing brokers who could not meet the capital requirements had to disappear. In this shakedown, only the biggest players were left standing.

In one respect, the large capital requirement of firms protects the client from the possibility of the broker going bankrupt, which had been a genuine fear. If the broker goes bankrupt, the client's funds would also be in jeopardy, and in liquidation, they would only get 2 cents on the dollar. Also the requirement to be regulated would force all firms to be more honest with their books and clients. Some of the regulatory benefits are:
  • NFA regulated brokers follow strict standards and procedures implemented by the NFA, which helps to ensures safety of client assets.
  • NFA regulated brokers cannot use client funds to carry out their business activities. They must backup all positions with their own capital or carry them over to the interbank market. Thus NFA brokers have to be large brokers with sufficient capital requirements (ergo, $20 mil capital requirement).
  • NFA regulated brokers submit their account balances to NFA at end of each week, and are subject to yearly audits.
  • NFA regulated brokers must have a licensed and specialty trained staff
In addition, requiring all brokers and dealers to register may go a long way towards minimizing fraud, which had been a plague for the industry.

On the negative side, the large capital requirement ensures the dominance of the largest brokers who started the industry and who already had the NFA in their pockets. The upstart Davids of the industry had to submit to the financial superiority of the Goliaths. No more small firms with better pricing, no more innovative platform features, no more competition. Industry insider lobbyists (i.e. the wealthy brokerage firms) approved of the legislation because it raised the bar to entry, prohibiting the upstart brokerages from entering into the rich boy club.

For a list of firms that are registered with the NFA and CFTC, click here.

With the passing of the Dodd-Franc Wall Street Reform Act of 2010 (signed into law by Obama in July 2010), the shift towards greater regulation foreshadowed in the 2008 Farm Bill was ratified and strengthened. The Act in a nutshell:
  • No over-the-counter foreign transactions, unless it is through a government-approved agency (NFA and CFTC).
  • No spot metals transactions (gold and silver), unless you plan to take delivery within 28 days. In other words, US traders will not be able to trade XAU/USD (gold) or XAG/USD (silver) in forex brokers in the United States.
  • Foreign brokers not registered in the U.S. will now be forced to terminate any and all relationships they may have with U.S. persons. In other words, the Act encourages all non-US brokers to shut their doors to U.S. persons, thereby hoping to prevent the U.S. person from taking his business elsewhere.
  • The removal of the "under 15 clients" exception for money managers and financial advisors.
Note: Even though the trading of forex and gold were not involved in the financial disaster of 2007, the event that produced Dodd-Frank, they nevertheless became the subjects for regulation and prohibition. Was this just accident, or was this intentional manipulation? The over-reach begs the question, and presents an interesting conspiracy theory as explanation.

Monopoly Conspiracy Theory Perhaps the CFTC and CME (who authored much of the new legislation), felt their futures products threatened from the competition with spot forex and gold. If we remember Chicago's mob history, they didn't like their monopolies disturbed. If US traders want to trade forex, they must do so through the CFTC and any new restrictions it mandates (e.g., Reduced Leverage and No-hedging).  If US traders now want to trade with gold, they must go trade the gold futures contracts at the CME. If US traders do not like these new restrictions, they are prevented from fleeing outside the borders, as the Act bullies foreign forex brokers from accepting US clients. Thus, the Chicago futures monopoly (CME and CFTC) uses its Washington allies (those responsible for the Farm Bill and Dodd-Franc, and Obama, who incidentally is from Chicago) to prevent competition with alternative financial products and providers, both internally and externally, and herd the bull and bear US traders back through its own gates. 

The 2008 Farm bill and subsequent Dodd-Franc Act of 2010 gave the NFA and CFTC tremendous leeway in crafting rules governing this new financial services category, and with this new found charter, these two agencies came up with two more tough rules, implemented in 2010, both ostensibly designed to protect the trader against himself, but both threatening at the time to dismantle the powerful advantages of forex: 

1) Leverage Restriction

The NFA and CFTC had wanted to cut the leverage down to 10:1 from the previously normal 100:1. If they had gotten away with this, they would have effectively made trading currency futures (at 25:1 leverage) more attractive than trading spot forex. Was this their "secret" intention, even though their stated intention was to protect the greedy trader from himself? After much flak from industry insiders, they conceded to cut the leverage down to 50:1 for the majors, 20:1 for the minors.

When I first learned of the leverage restriction, I was very upset. A 100:1 leverage for forex was a powerful advantage over all other markets, as it could enable the trader to take advantage of higher leverage in cases of opportunity, hardship, or diversification. That being said, a prudent trader should never use more than 2:1 leverage per trade anyway, and no more than 5:1 in aggregate positions, so a leverage reduction to 50:1 should not crimp a professional money management style. A leverage restriction to 10:1 would have been intolerable.

2) Anti-Hedging (FIFO) Restriction

The NFA enacted rule 2-43(b) which effectively eliminates hedging by forcing brokers to close trades on First In, First Out (FIFO) basis. Basically, if you open more than one position on a currency pair, you must close the first before closing the second one. That’s the NFA’s not-so-straightforward way of preventing hedging. Their position is that hedging provides no economic benefit. However, the rule has the secondary impact of preventing a trader from having multiple strategies on the same pair in the same account. 

In theory, this anti-hedging (FIFO) restriction would seriously affect you if 1) you are using hedging techniques; and/or 2) you have more than one position on a specific currency. Many traders do hedge, and many more (myself included) have more than one position on a specific currency. I definitely did not like this rule when it first came out. 

However, things did play out better in practice. Some of the smarter US brokers managed to escape how this anti-hedging (FIFO) rule affected their clients. Some US brokers were lucky enough to have subsidiaries abroad, so they already bypassed the new rules. Other US brokers found a method of compliance that sorted out the hedging rule in the backend, so you need not worry about it.

For instance, Scott Wang of Forex Verified has created a cool US Broker Comparison Chart to organizes how the top US brokers deal with the FIFO and NO-Hedging rules (information current as of Oct 14,2010):

Broker Min Lots Min Deposit FIFO Enforcement Non Hedging Enforcement
FXDD 0.01 100 Back Office Back Office
Gain Capital
0.01 500 MT4 Platform MT4 Platform
0.01 250 Back Office MT4 Platform
FXCM 0.10 2000 Back Office Back Office
Alpari  0.01 250 MT4 Platform MT4 Platform
MB Trading 0.01 400 Back Office MT4 Platform
ATC Brokers 0.10 5000 Back Office Back Office
Oanda 0.01 50 MT4 Platform MT4 Platform

What is the difference between Back Office and MT4 Platform enforcement?

When brokers use "Back Office" enforcement, it means that these rules are enforced automatically for you on the Back Office account. However, in your Metatrader 4, you still experience full trading functionality, so all your EA's work properly as they should. US clients operating with such brokers do not have to worry about the rule interfering with multiple strategies or EAs working on the same pair in the same account.  

According to Scott Wang,
When brokers use "MT4 Platform" enforcement, it means that the rules are enforced directly in the Metatrader 4 platform. If you attempt to place a hedged trade you will receive a "Hedging Prohibited" error message. If you try to close out a 2nd position before a 1st position, you will receive a FIFO error message. In these cases, your MT4 platform does not have full trading functionality and some of your EA's may not work properly.

Razor Tip! If you want to minimize to the point of invisibility the impact of the No-Hedge (FIFO) restrictions in your MT4 platform, trade with the broker that has the "Back Office" for both FIFO Enforcement AND Non-Hedging Enforcement.

If the broker is not on the list above, you should take a few steps to find out. You should ask for an explanation from your broker, asking if it enforces FIFO and No-Hedging on the MT4 platform or the Back Office. You should also demo trade their account to make sure. If you are not pleased with your new broker's software limitations, you can check out another US broker's software, or you can open an account offshore


Perhaps it was time that US forex firms were obligated to be regulated, as many financial firms in the US already were. While the forex industry was not a cause of the 2007 financial disaster, the forex industry had been growing at an exponential rate throughout the 2000s, and new firms and introducing brokers were popping up everywhere, most decent and good enough but some very bad and very ugly. There have been cases of roguish firms and institutions stealing the fortunes and dreams of innocent investors in different forex related scams and ponzi schemes across the country (First Capital Savings & Loan Ltd, CRW Management LP, Botfly LLC, Yellowstone Partners, M25 Investments Inc., Alpha Trade Group, etc.). Often the CFTC has been the sheriff on the white horse riding into town to put a stop to these bandits. For this they do deserve a salute. We are probably better protected from fraud by such an agency than without.

Nevertheless, I do think that too much power was granted to the CFTC (a regulatory body allied with the futures industry) by the 2008 Farm Bill and Dodd-Frank Act of 2010, and that it misused this power in calling for a severe restriction of forex leverage and hedging. If it had gotten away with what they wanted -- 10:1 leverage and absolute No-Hedging-- they would have shot out the knee caps of US Forex, forcing many traders back into the futures arena or sneak away to offshore forex providers. In the end, however, the leverage restriction of 50:1, though not ideal, is tolerable when in keeping with sound money management principles. Moreover, there are many clever ways to minimize the No-Hedge rule, such the Back Office compliance procedure adopted by US brokers that effectively makes it invisible to the client.

Ultimately, given that there have been positive push-backs against bad regulation, I am not about to abandon the US Forex Arena just yet. There is still hope. However, if you are not happy with the way that Washington, the NFA and the CFTC have been regulating the US Forex Arena (such as prohibiting spot gold and silver trading, restricting leverage and hedging, prohibiting foreign broker access etc.), and who knows what else they might have in store for us in the future, you can attempt to take your money to a foreign broker where these US Regulatory agencies cannot get you. The Dodd-Franc Act may have already scared many foreign brokers to shut their doors to US clients, but there are still a few that are accepting (e.g., FinFX). Moreover, even with the scared foreign brokers, there are still legal and subtle ways of getting an account set up with them if you think a little outside the box.

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