Few days ago Commissioner Jill E. Sommers from the CFTC gave a speech at the FIA/FOA International Derivatives Expo in London and besides thanking and flattering half of the world’s regulators she also managed to outline the regulatory roadmap and mentioned a few of the most critical issues that the CFTC is going to handle in the near future.
The topics mentioned by Sommers might prove what I’ve been suspecting for a quite a while: Forex trading in the US is on the road to become an exchange just like the equities and futures are centrally traded. This would probably take a while to materialize and several steps would need to happen first, but it seems that more regulation is the likely outcome of the steps CFTC is aiming to undertake.
However there are also several good things that this will create: a big emphasis on STP processing of orders meaning traders will trade with other traders big or small and not against its own broker, which clearly has other interests. OTC products (Forex is probably one of them) are also going to be much more transparent and reporting will become a bigger issue than what it is now.
This all seems to be for the benefit of the trader but is also expected to drastically change the face of the Forex industry in the US:
First of all, brokers will gradually shift from being a ‘house’ to being simply a technological platform providers connecting the trader to the currency exchanges just like E-Trade and Schwab do in equities.
Secondly, Forex brokers’ income from a single trader is expected to drastically decrease on one hand (not being able to take side means brokers won’t profit from clients’ losses but will earn commissions on volume only) and competition for every client will increase, on the other (the more standardized the service given, the harder it is to convince a client of an added value). Marketing (client acquisition) costs will skyrocket, some brokers will go out of business and others will move offshore.
Thirdly, the increased competition will also benefit the trader as brokers will have to offer value added services such as education, signals, trading systems, analysis and etc., possibly for free.
Lastly, some US clients will move to offshore entities, just like they do now, but many more of those who were reluctant to trade Forex so far will see that trading Forex on an exchange is as transparent as trading equities or futures and it’s just another financial product. I expect the number of US Forex traders to grow as a result.
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This of course is very ambitious, even for the CFTC, as regulating a market which is 100 times larger than NASDAQ and NYSE combined is not going to be easy.
Major issues that the CFTC plans on addressing in the near future are:
This anticipated regulation would subject OTC derivatives dealers to conservative capital requirements, initial margin requirements, business conduct rules and recordkeeping and reporting requirements. In addition, derivative markets would be regulated based on the following four principles:
1. Require all standardized OTC products to be cleared through regulated clearinghouses;
2. Move standardized portions of these markets onto regulated exchanges and regulated transparent electronic trading systems;
3. Develop a system for reporting and disseminating OTC prices and other OTC trade information; and
4. Require all OTC transactions, both standardized and non-standardized, to be reported to a regulated trade repository, make aggregate data on open positions available to the public, and data on individual trades and positions available to the CFTC and other regulators on a confidential basis.
Chairman Gensler also called for clear CFTC authority to police fraud, manipulation and excessive speculation in the OTC space and for the need to establish position limits. In order to prevent traders from avoiding position limits by moving to a regulated exchange or market. She recommended that the agency be given the power to set limits on OTC positions and that limits be aggregated across all markets and trading platforms, including foreign exchanges that have received no-action relief from the CFTC to offer look-alike contracts to U.S. customers. She urged, moreover, that Congress give the CFTC clear authority to promulgate rules governing foreign boards of trade doing business in the U.S.
For some reason the document, which I still managed to find, was removed from CFTC’s website. For your convenience, and for CFTC’s apparent inconvenience, it is embedded below.