by Erich Grant, Shift Forex
originally published in the NIBA Journal
On October 18th 2010 the NFA and CFTC issued a set of new rules governing the retail forex industry, dramatically tightening the regulatory regime under which forex firms operate. Many in the retail forex industry feared the new set of regulations would push most or almost all of the business out of the United States. Indeed, many market participants have been forced to cease doing business or have pulled out of the country and stopped accepting US clients.
Far from destroying the industry, these new regulations have laid the groundwork for the next dramatic stage in the forex growth story. While tightened regulations have decreased the per-trade profitability for brokers and some market participants, the newly legitimized industry can now begin to further build its reputation and promote the spread of forex as a true alternative asset class. US-based customers are now legally mandated to open accounts with US-registered brokers, creating a captive audience of potential clients – and the CFTC has been aggressively pursuing overseas brokers who continue to target and accept US customers. The two largest US-based retail forex brokers have gone public, adding another layer of both regulatory scrutiny and legitimacy in terms of investor perception. These changes have allowed for the creation of a much more honest, transparent playing field.
Opportunities for New Market Participants
The removal of many of the existing market participants has created a unique moment in the history of this growing industry. While the industry continues to sort itself out, a decline in the number of firms offering retail forex has opened the field to new players. IBs traditionally focused on commodities and futures business (‘Futures IBs’), Commodity Trading Advisors, and Commodity Pool Operators are all well positioned to take advantage of this opportunity. Futures IBs, CTAs, and CPOs are both already uniquely familiar with the strong selling points associated with alternative asset classes, and continued turbulence in the equity and debt markets only adds to the allure of non-correlated assets.
Offering forex allows commodities brokers to differentiate themselves from their competitors through a new suite of tradable products. Forex is a high margin product, with low barriers to entry for customers (significantly lower required initial deposits, simple online applications, and credit card funding), low market penetration, and a still rapidly growing client base. Forex markets are trade-able 24 hours a day, adding flexibility for customers and increasing trading volumes for brokers. Most retail traders are trading as a hobby, rather than a career. The ability to trade after the normal working day is over partly explains the high number of daily trades per client at retail forex brokers. Additionally, as mobile technology has dramatically advanced in the last few years, position traders are able to monitor and place trades from almost any location, further driving brokerage volumes.
While regulations have capped forex leverage at 50 to 1 for “major” forex pairs (down from 200 to 1 prior to last October), this still offers investors a much more highly leveraged instrument than traditional equities and interest rate products (Disclosure: The high degree of leverage can work against traders as well as for them). As US-based brokers are barred from offering Contract for Difference (CFDs) trading to their customers, the ability of Futures IBs to offer both forex and more traditional commodity products will establish a strong differentiation factor between them and Futures IBs who do not offer forex.
For CTAs and CPOs, managed forex programs provide another unique alternative asset class to existing and new clients. The growing public awareness of the importance of currency fluctuations makes managed forex an especially attractive investment for clients who are worried about currency depreciation but are unable or unwilling to directly trade a forex account. Forex brokers have developed attractive account management structures that make it relatively easy and simple to onboard new accounts. The fact that CTAs and CPOs must have their performance audited acts as another powerful legitimizing force, eliminating one powerful objection from potential clients.
Futures market participants already have much of the sales infrastructure deployed to offer these products, and many forex brokers will work with their partners to enhance the “bolt on” nature of adding forex trading to their product suite. For firms interested in expanding their product offerings, recent industry upheaval makes now an attractive and exciting time to test the waters.