With new regulations and enforcement actions in the retail foreign exchange (Forex) brokerage industry, it seems we are witnessing the gradual maturation period of the currency markets. The baby we once knew as the so-called wild west of financial markets is slowly growing into its teenage incarnation as well-known retail brokers are slapped with fines and... lawsuits from the US government.
"Lawsuits?" You ask.
That's right, the US regulatory bodies have resorted to lawsuits as a means of enforcing the American regulations against foreign domiciled entities.
It's a dangerous ledge to be walking on. On the one hand, it's great to see that the industry, once chock full of unscrupulous marketers and bucket shops, is becoming a legitimately regulated financial market (at least in terms of its retail brokerage operations.) On the other hand, the United States is dangerously close to violating the freedoms and rights of its own citizens by effectively banning individual traders who are resident in the U.S. from opening live trading accounts at unregistered foreign-domiciled FX brokerage companies.
The online foreign exchange trader community had long debated over the new maximum leverage rules and FIFO rules. While I would lean toward the argument that those rules were ultimately beneficial to beginner traders, the new attempts at enforcement actions against overseas entities might be taking it a step too far.
While I'm sure I will kick up a storm among many retail Forex traders with the above statement, it may not be for the reasons immediately obvious to those who may not be familiar with the online Forex traders communities. The part I'm referring to is the FIFO rule: first-in first-out, a basic accounting principle in all recognized standards of accounting, which in the context of the Forex market, results in a rule that the old "hedging" (taking opposite positions in the same symbol) in retail FX platforms would no longer by allowed.
To be clear, real hedging in the institutional context involves taking a position in an instrument (for example, a stock such as Home Depot) and "hedging" it with a statistically correlated (but different) instrument, such as Lowes in the example. Taking a long and short position in the same stock would cancel each other out and render the trader's net position flat (zero exposure) therefore all brokerage platforms would show a zero position for this locked trade.
In the retail foreign exchange world, however, traders had long been offered the option by brokers (many of which were known to operate dealing desks which effectively took positions against their own clients) to hold locked positions in a so-called "hedge" and charge swap rates on both sides. Essentially, brokers took the opportunity to charge a fee for two positions that added up to no exposure.
Still, there is a small segment of mathematically challenged traders who are convinced that there is a practical benefit to paying swap interest for a flat position.
What does all this have to do with the current regulatory tightening in the Forex industry?
Education.
Perhaps a better alternative to out-of-jurisdiction lawsuits, and outright removal of citizens' freedom of choice, might be to encourage education on simple matters such as net market exposure and risk management. Instead, there is a long-established tradition among regulators to treat its citizens as self-destructive children and simply impose arbitrary laws such as the Pattern Day Trading rule added after the tech bubble burst.
With enough experience in the markets, especially in a long-term ranging two-sided market like foreign exchange, traders come to understand that the ups and downs of the markets are the natural ebb and flow of greed and fear in all financial markets.
For politicians, there is a much simpler algorithm:
Markets go up, leads to happy individual investors, equals time to take credit for things beyond any single individual's control.
Markets go down, leads to bubble chasers losing money, equals tighter regulations to superficially satisfy the short attention span expected from the crowd.
What new arbitrary regulations will be introduced following the next bear leg of the over inflated equities markets? Only time will tell.
For now, it's good to see that the retail Forex industry is slowly growing. If only politicians could grow out of attempts to cater to the masses by limiting freedoms as an alternative to education and information transparency.
Evan Frankson launched his trading career as a proprietary trader and later transitioned into the global Forex markets. With extensive experience in the institutional side of the FX industry, Frankson contributes unique views and commentary on the retail Forex brokerage business, and honest unbiased views on trading in the world's largest OTC market, on the FX Helpline Forex Blog at http://www.fx-helpline.com/
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