In this article we will cover:
- Overview of US forex regulatory organizations
- Who is regulated in the US forex industry?
- Why does any of this matter for my forex trading?
- Regulations that apply to US forex brokers, under the NFA
- Why simply choosing a regulated broker does not offer you enough protection
US forex regulatory organizations:
The following are the organizations that regulate retail forex trading:
Commodities Futures Trading Commission (CFTC): The CFTC has the ultimate regulatory authority over the futures markets, which includes the forex markets. The Commodities Exchange Act provides the legal framework within which the CFTC operates. The CFTC established a set of CFTC regulations to govern the futures and forex trading markets. All non-bank forex brokers dealing with retail clients are covered by the CFTC regulations.
National Futures Association (NFA): The NFA is a self-regulated organization for the futures and forex industry and serves as a watchdog for the industry. The NFA has put in place rules of conduct for its members that go beyond the CFTC regulations. The NFA has the power to issue fines and to suspend operations of their members. They also provide dispute resolutions services to arbitrate disputes between investors and NFA members. All non-bank forex brokers dealing with retail clients must be NFA members and be subject to NFA rules.
Office of the Comptroller of the Currency (OCC): The OCC is an independent bureau of the U.S. Department of the Treasury. The OCC is responsible for regulating futures and forex trading for national banks and foreign banks. The OCC has put in place regulations to govern banks as required by the Commodities Exchange Act. All banks dealing in forex transactions with retail clients are subject to these OCC regulations.
How this fits together:
1) The OCC regulations are much more recent, but were designed to align with the CFTC regulations. The two sets of regulations are almost the same.
2) If a forex broker is a bank, that bank is regulated by the OCC and must comply with the OCC regulations
3) If a forex broker is not a bank, then that broker is regulated by the CFTC and the NFA. That broker must follow both the CFTC regulations and the NFA rules.
4) For NFA rules, or smaller CFTC regulatory violations, the NFA may handle all the enforcement work against a broker
5) For more serious violations, both the NFA and the CFTC may take action against a forex broker, with a separate set of judgments and fines made against that broker.
See the following for a visual representation of the US forex regulatory relationships:
Who is regulated in the US forex industry?
1) Retail Foreign Exchange Dealer (RFED): For brokers who deal primarily with forex trading, the RFED is usually the counterparty to your forex trade. If you buy the EUR/USD, the counterparty is the one who is selling the EUR/USD to you. In forex trading, if you win and make money, the counterparty loses that money. If the counterparty makes money, it is because you lost money. RFED’s want you to lose your money so that they can make money. For retail forex trading, your forex broker is often an RFED. Technically, a counterparty is not a broker, but a dealer. However, “forex broker” is a widely used term used by retail traders that also refers to dealers, so this site will keep with that convention. Just be aware that you are generally trading against your “broker”, which is a conflict of interest. Note that brokers who use straight through processing to offset your trade with other counterparties are not in as direct a conflict.
2) Commodity Pool Operator (CPO): A CPO pulls together money from many investors and trade the combined funds together as a pool. A large forex hedge fund would be an example of a CPO. As well, smaller managed forex accounts can also be CPOs. Note that CPOs do not have to be NFA members if:
- they are a bank
- they have less than $400,000 in capital or have less than 15 investors contributing to the pool
- those who do not advertise or earn compensation for running the pool (like uncle Bill running a managed fund for his extended family)
3) Commodity Trading Advisor (CTA): A CTA provides certain forex trading advice to customers. The kind of advice that qualifies includes having direct trading authority over a customer’s account, or giving forex trading advice that is specifically tailored for a customer. The following are not CTAs:
- you do not represent yourself as a trading advisor
- you are giving general trading advice that is not tailored to an individual. This includes most trading recommendations where everybody is receiving the same advice
4) Introducing Broker (IB): An IB solicits business from customers to trade forex, but does not handle any of the money or get involved in executing the transactions. An IB typically drives forex customers to a retail foreign exchange dealer (your broker). The IB is usually paid a share of the money which that dealer makes from the customer.
Why do forex regulations matter for my forex trading?
It matters because the forex brokers and other industry players with the most regulatory oversight are less likely to scam you. Those that are less regulated or not regulated are much more likely to scam you. Here are some related points:
- Unregulated Commodity Pool Operators: smaller managed funds are not subject to regulatory oversight. Managed funds are one of the key types of scams that we elaborate on in more detail. THe most important thing for you to remember if that if you are going to participate in a managed fund, make sure it is a fund that is registered with the regulators. That way you will benefit from regulatory protection, and have a better means to recover funds in the event that the fund engages in fraud.
- Unregulated Commodity Trading Advisors: there are a ton of sources on the internet giving detailed forex trading advice. Most of it is bad advice. By giving the advice in a generic fashion, such advice is not subject to regulation. This area is full of scam artists. You should be very mindful of your sources of trading advice. Above all, never give trading authority to a third party unless they are a regulated commodity trading advisor. This will give you better protection in the event of a fraud.
- The NFA is one of the most effective financial regulators on the planet. They keep a close watch over their members, and they go after them pretty hard in the event of wrongdoing. They require their members to follow additional rules vs what the CFTC and OCC regulations require. As such, you should consider choosing a forex broker is an NFA member, rather than a bank offering brokerage services that are only subject to to the OCC regulations.
- RFEDs in the US (your forex broker) must make many disclosures to you. They are not allowed to engage in any fraudulent activity or to deceive their customers. They must let you know what you are getting into.
Regulations that apply to US forex brokers, under the NFA:
The following summarizes key NFA rules that apply to NFA members who transact forex with customers who have assets less than $10 million (your broker, which is technically a dealer):
Risk Disclosures: Members who solicit customers must provide risk disclosures prescribed by the CFTC that cover the following:
- Your dealer is the counterparty to your trades, which is a direct conflict of interest
- The electronic trading platform is not an exchange, but merely a connection to your dealer
- The money you deposit with your dealer has no regulatory protection. In case of bankruptcy, the funds you deposited with your broker are considered unsecured creditor’s claims
- Your dealer chooses the prices that are available to you. The prices offered to you may be different from the prices offered to a different customer
- An introducing broker may receive compensation from your business with the dealer in ways you are not aware of
- The risk disclosure must also inform the customer of the number of retail forex accounts and the percent that are profitable.
Additional disclosures are advised if forex trading is not advisable for a potential customer based on financial goals, financial resources or forex trading inexperience.
Communications with public: For communications and promotional materials for the public, written procedures must be created and enforced that align with the following:
- The materials must not be fraudulent or deceitful, use high pressure sales tactics or imply that forex trading is appropriate for all customers
- No representation can be made that deposited funds are segregated or have special protection under bankruptcy laws
- If claims are made that trading is commission free, the actual means of compensation must be prominently disclosed
- No claim may be made for guaranteed fills or no slippage unless this can be proven to be the case, and that the customer contract aligns with this fact
- Any mentions of potential profit must be accompanied by equally prominent disclosures of the risk of loss
- Claims of hypothetical performance that could be achieved by a customer using a member’s systems must by accompanied by specified risk disclosures as well as a comparison to performance of actual customers over a similar time frame
Price Adjustments: Adjusting or canceling the price of an order after it is executed is generally not permitted, with two exceptions:
1) The adjustment is in the customer’s favor, and is applied to all similarly affected customers who would benefit from the adjustment
2) The following apply:
- The FDM only uses automated straight-through processing to enter into offsetting positions with another counterparty
- The price of the offsetting position was adjusted or canceled by the other counterparty
- The adjustment and notification to the customer take place within 15 minutes of the original order execution
- All customers affected by the adjustment or cancelation made by the other counterparty receive the adjustment, regardless of whether the adjustment is favorable or not
Price slippage happens when the price of an instrument changes between the time an order is placed by a customer, and is received by the FDM. This is permissible if either:
1) The price is requoted to the customer
2) The order is executed at the slipped price, the slippage is applied consistently regardless of whether it is favorable to the FDM or not, and the rules for handling how slippage is applied is disclosed to the customer in advance of trading
Capital Requirements: Generally, forex dealers are required to carry net capital of $20 million + 5% of liabilities owed to customers. In some cases it may be more than this.
Other: there are additional requirements for recordkeeping, reporting, supervision, NFA reporting, membership dues, and anti-money laundering.
Why simply choosing a regulated broker does not offer you enough protection
Simply put, many forex brokers have violated US forex regulations. In many cases, forex brokers have repeatedly violated those regulations. In many cases, the regulatory violations appear have been deliberate, with the intent to break the rules to take more money from their customers.
On the other hand, there are several forex brokers who have never been subject to any regulatory action over all the years they have been dealing in forex. This would appear to represent an effort to run an honest business with fair treatment to customers.
What kind of forex broker do you want to deal with?