The Commodity Futures Trading Commission (CFTC) has published final rules for the regulation of off-exchange retail foreign exchange transactions (retail FX). The regulations are effective October 18, 2010. The new retail FX rules involve a broad scheme of registration, disclosure, recordkeeping, financial reporting and minimum capitalization. The new regulatory framework was intended to apply the existing rules for on-exchange futures trading to retail FX in a manner that is as similar as practical.
The CFTC historically did not have a clear grant of jurisdiction to regulate foreign currency forward contracts (FX). While the Commodity Exchange Act was clear in its grant of exclusive jurisdiction to the CFTC to regulate exchange-traded futures contracts, its jurisdiction was not as clear with respect to off-exchange FX. For this reason, certain retail FX firms, including some that allegedly engaged in widespread and egregious investor fraud, were successful in rebuffing CFTC enforcement actions against them based on jurisdictional arguments.
It is important to note that the new regulatory scheme governs only “retail FX.” Retail FX is defined as FX transactions with someone who is not an eligible contract participant (ECP). Generally, the Commodity Exchange Act defines ECPs as persons or entities that have at least $10 million in assets. However, commodity pools currently are ECPs if they have at least $5 million in assets and the sponsor of the fund is subject to the regulation of the CFTC. The new CFTC rules for retail FX do not apply to those commodity trading advisors, commodity pool operators and introducing brokers whose clients are exclusively ECPs.
Industry registrants should be aware that the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) substantially increases the ECP standard for commodity pools that engage in FX. Effective July 21, 2011, for a pool that engages in FX to be an ECP, all participants in the pool must themselves be ECPs. (If the pool does not engage in FX, the current qualifications for a pool to be an ECP will remain unchanged at $5 million in assets.) Financial institutions, investment companies, insurance companies and ERISA plans will continue to qualify as ECPs under Dodd-Frank.
The final rules also create a new registration category – registered foreign exchange dealer (RFED). The CFTC Reauthorization Act of 2008 created a new $20 million minimum net capital standard for RFEDs, and futures commission merchants (FCMs) that engage in retail FX. FCMs that are primarily and substantially engaged in the exchange-traded futures business are not required to also register as a RFED.
Other CFTC registrants (commodity pool operators, commodity trading advisors and introducing brokers) that engage in retail FX will have to register (unless otherwise exempt or already registered) in their respective capacities. Current registrants who wish to engage in retail FX will have to amend their registration to reflect their use of retail FX and comply with the various FX compliance, disclosure and reporting requirements.