The news about the NFA shaking up the forex industry by dramatically raising capital requirements has kicked off a lot of speculation.
posted July 30, 2007

New rule changes proposed by the National Futures Association (NFA) could have a significant effect on several brokerages that trade foreign exchange. The NFA wants to raise capital requirements for all registered Forex Dealer Members (FDM) to $5 million, plus it wants improved accounting standards. The NFA is hoping the increased standards will prevent the ongoing problem of forex brokerages going bankrupt and/or committing fraud.

The NFA said it has been concerned about the lack of protection for FX customers. "From what we've been seeing and the enforcement actions we've been taking recently, for the protection of the customer in the markets, we really need to raise the minimum capital requirement for these firms," said a Chicago-based NFA spokesman.

FX Week states, "Following redrafting to include industry feedback, the proposals will be presented to the NFA board in August and then to the CFTC, and are not expected to be effective until the end of the year, the NFA explained."

The proposal could potentially wipe out 90 percent of existing forex brokerages, although itís likely major consolidation would occur if the rule passes. work.

The NFA estimates the new rules, combined with existing rules, will force firms to have at least $10 million in adjusted net capital to remain in business.

According to data obtained from the CFTC, the new rules would leave only six forex brokerages. CFTC's May 31 report of adjusted net capital holdings, which showed CMS holding $11,512,421, FXCM $55,668,469, FX Solutions $12,650,227, Gain Capital $18,694,143, GFT $47,681,883, and Oanda $35,361,139.

The NFA listed few specific reasons for the rule change.

One of the reasons for the 2006 increase to the FDM capital requirements was that an FDMís dealer activities create greater financial risks than the agency transactions involved in traditional exchange-traded futures and options. A second reason is that the need for adequate capital is particularly acute for FDMs since customers trading off-exchange forex have not received a priority under the Bankruptcy Code in the event of a firmís insolvency. Both of these reasons still exist.

Second, trading spot forex, which FDMs do, creates more risk than trading futures and options listed on an exchange. Second, since spot forex is not a priority under the NFAís Bankruptcy Code, itís particularly important for FDMs to have adequate capital. Plus, two of the three bankruptcy proceedings in which the NFA has taken part in the past four years have involved smaller FDMs, and with the cumulative amount of retail funds under account surpassing $1 billion, the NFA is concerned that an FDM might be unable to meet its financial obligations to its customers.

As a result, firms that meet the new capital requirements will also have to file an internal control report prepared by an independent auditor, and the NFA would have limited ability to request certification of an FDMís finances. Also, each FDM would have to designate an individual to oversee the firmís finances, and that person would be subject to discipline if accounting and capitalization rules are not followed.

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