Earlier this month, the NFA sent its members a ‘Request for Comments’ letter are about the prohibiting of credit card payments. The NFA’s Compliance & Risk Committee (CRC) is concerned that these payment solutions promote depositing with borrowed funds and small sized deposits which barely cover minimum margin requirements. In their words “The CRC is concerned that retail customers may be opening accounts with funds that are not risk capital and are using credit cards as a source for borrowing funds to invest. The CRC’s overall concerns with this practice are compounded by the fact that many FDMs that offer this funding mechanism also permit retail customers to open an account with a very low deposit amount (e.g., $100) that merely covers the intended transaction’s initial margin requirement. Any slight movement in a customer’s forex position causes the customer to quickly fall below the margin requirement for the transaction.”
At Forex Magnates we have been admittedly late in reporting this piece of news, partly due to preferring to speak with market participants to gauge the impact of what a ban on credit card deposits would mean. On first glance it appears as another swing by the regulators against the US FX industry, as forex firms are the only brokers within the NFA’s umbrella accepting credit card deposits. Also, in the above mentioned quote, forex was highlighted. As such, the actions are being viewed negatively and other media sources are calling this more proof that the NFA is out to destroy the US retail FX market. However, the actual impact of any such rule will depend on the operations of each broker.
For large, multinational brokers with financial licenses from multiple countries, the US market has been steadily contracting. As such, a credit card ban would be disruptive to their operation over the short term, but the total effect of on their bottom lines is expected to be negligible. In fact, long term these brokers could benefit due as costlier payment methods would be expected to lead to larger average deposit sizes. On the other end of the spectrum are brokers with a large concentration of US clients. Specifically, any firm with an aggressive sales and retention staff that focuses on low initial deposits and reoccurring re-deposits will suffer. Similarly, affiliates with cost per acquisition (CPA) deals who often push ‘get rich quick’ marketing on the sites will most likely see a sharp drop in conversions. However, with ‘self deposits’ where clients can begin trading before documents are sent to a broker’s compliance team for review not in existence in the US, as well as greater enforcement on malicious dealing desk taking place, ‘get rich quick’ schemes from US affiliates have been focusing their marketing out of the US market.
As of now there is no timetable yet in place to the formation of a credit card ban, and ‘Requests from Comments’ are typically followed by a public meeting which hasn’t been set. In Forex Magnates Q4 Industry Report, we took a look at the Payment Industry. The article was focused on Credit Card deposits and Real Time Bank Transfers which are very popular in Europe. One of the conclusions of the article is that the payment solutions industry is experiencing many changes and innovation, specifically in its adaption to cross border payments and mobile. Therefore, while credit cards are an essential part of the US FX industry, it is safe to assume that alternate forms of payments won’t take long to fill the gap. On this point, Oanda’s CEO K Duker answered in a Reddit AMA that he expects digital currencies like bitcoin to play a bigger part of payment solutions for firms in the future.
Potential Benefits (Alternate Opinion)
Beyond the immediate disruption, it can be argued that such an action from the NFA would be the best thing that could happen to the US retail FX industry as it will force brokers to focus on targeting quality traders.
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Unlike in many other parts of the world, in the US, FX competes against an established market of equity and futures day trading. FX was a late arrival to scene and owes its initial marketing push to the Dot com bubble burst of 2001 when the Nasdaq lost 70% of its value. Initial marketing was aimed at traders that had been burned by the falling markets and slogans included “good stock traders can become great FX traders” as well as “profit in both rising and falling markets.” While the industry was able to convert clients, it was beset with scandals like REFCO and market rigging complaints in its early days that have cast a suspicious eye on the retail FX market. As such, despite an increase in volumes and numbers of traders, the industry continues to lag far behind other asset classes in the US in terms of ‘perceived’ transparency and honesty. This is partly due to the market making nature of the product as well as gimmicky marketing that is seen over and over again. Therefore, to truly evolve and become a long term product to rival with the heavily entrenched equity and futures market, brokers need to completely shed the ‘get rich quick’ feel that still exists within FX and start targeting traders!!
On an overall level, FX as an asset class has reached parity with many of its rivals. With its levels of liquidity and tight spreads, cross asset traders are heavily involved with analyzing and trading the product. This has been specifically seen in the CME where overall FX volumes have risen 10 fold in the last ten years, with systematic cross asset traders entering FX being touted as one of the main drivers of volume. That being said, the issue in the US doesn’t seem to be a lack of interest in FX as much as an inability for retail brokers to source semi-professional clients.
Adding restrictions on credit card deposits will force the US industry to focus its means on converting real traders. What is a real trader? In my opinion, someone who is willing to make a serious effort to become a successful trader. Part of that serious effort is having a realistic view on risk management and size of trades. When you take a look at the average sub $2000 account, there just isn’t much of an opportunity to generate a consistent return to justify the ‘opportunity cost’ of spending one’s time trading. Therefore, this typically leads to ‘gambling’ taking place and the ‘hope’ of scoring a 2X or greater trade. As such, these clients that are enticed with low deposit minimums and high leverage have historically shown a high failure rate when compared to customers trading larger accounts and spending more time in front of the screen.
Therefore, while a lack of credit card deposits will lead to an initial blow to the industry, it will cause a prescreening of clients to take place and lead to an industry that is composed of higher quality customers who trade greater volumes with a longer lifetime value.
Interested to hear the comments and opinions of our readers on this sensitive issue.
Readers looking to get in touch with the CFTC to complain (or support) should email Elizabeth C. Sheridan, Senior Attorney at firstname.lastname@example.org by February 7, 2013.