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The Commodity Exchange Act permits persons regulated by a federal regulatory agency to engage in off-exchange forex transactions with individual investors only pursuant to rules of that federal regulatory agency. Keep in mind that there may be different requirements or treatment for forex transactions depending on which rules and regulations might apply in different circumstances for example, with respect to bankruptcy protection or leverage limitations.
You should also be aware that, for brokers and dealers, many of the rules and regulations that apply to securities transactions may not apply to forex transactions. The SEC is actively interested in business practices in this area and is currently studying whether additional rules and regulations would be appropriate.
Home Previous Page. Background: Foreign Currency Exchange Rates, Quotes, and Pricing A foreign currency exchange rate is a price that represents how much it costs to buy the currency of one country using the currency of another country. An example of such an exchange is the Chicago Mercantile Exchange, which offers currency futures and options on currency futures products.
Exchange-traded currency futures and options provide traders with contracts of a set unit size, a fixed expiration date, and centralized clearing. In centralized clearing, a clearing corporation acts as single counterparty to every transaction and guarantees the completion and credit worthiness of all transactions.
Exchange-traded options on currencies also provide investors with contracts of a set unit size, a fixed expiration date, and centralized clearing. In the off-exchange market. In the off-exchange market sometimes called the over-the-counter, or OTC, market , an individual investor trades directly with a counterparty, such as a forex broker or dealer; there is no exchange or central clearinghouse.
Instead, the trading generally is conducted by telephone or through electronic communications networks ECNs. In this case, the investor relies entirely on the counterparty to receive funds or to be able to trade out of a position. Risks of Forex Trading The forex market is a large, global, and generally liquid financial market.
While many currencies are typically quoted against the U. Both the Euro and the British pound, for example, may be quoted in the reverse, meaning that one British pound purchases a specified amount of U. Before deciding to invest in the forex market, check with several different firms and compare their charges as well as their services.
There are very limited rules addressing how a dealer charges an investor for the forex services the dealer provides or how much the dealer can charge. Some dealers charge a per-trade commission, while others charge a mark-up by widening the spread between the bid and ask prices that they quote to investors. In addition, some dealers may charge both a commission and a mark-up. They may also charge a different mark-up for buying a currency than selling it.
Read your agreement with the dealer carefully and make sure you understand how the dealer will charge you for your trades. For certain currencies and currency pairs, transaction costs can be relatively large. If you are frequently trading in and out of a currency, these costs can in some circumstances turn what might have been profitable trades into losing transactions. A small sum may allow you to hold a forex contract worth many times the value of the initial deposit.
Because currency price movements can be small, many forex traders employ leverage as a means of amplifying their returns. The smaller the deposit is in relation to the underlying value of the contract, the greater the leverage will be. If the price moves in an unfavorable direction, then high leverage can produce large losses in relation to your initial deposit.
With leverage, even a small move against your position could wipe out your entire investment. You may also be liable for additional losses beyond your initial deposit, depending on your agreement with the dealer.
Though it is possible to buy and hold a currency if you believe in its long-term appreciation, many trading strategies capitalize on small, rapid moves in the currency markets. For these strategies, it is common to use automated trading systems that provide buy and sell signals, or even automatic execution, across a wide range of currencies.
The use of any such system requires specialized knowledge and comes with its own risks, including a misunderstanding of the system parameters, incorrect data that can lead to unintended trades, and the ability to trade at speeds greater than what can be monitored manually and checked. Beware of get-rich-quick investment schemes that promise significant returns with minimal risk through forex trading. Contact the appropriate federal regulator to check the membership status of particular firms and individuals.
Special Risks of Off-Exchange Forex Trading As described above, forex trading in general presents significant risks to individual investors that require careful consideration. Unlike the regulated futures and options exchanges, there is no central marketplace in the retail off-exchange forex market. In these cases, market makers are acting as principals for their own account and, as a result, may not provide the best price available in the market. Members should adopt and enforce written procedures regarding communications with the public.
For example, you may not represent that forex funds deposited with a Member are "segregated" or given special protection under the bankruptcy laws. If an FDM or an IB represents that its services are commission free, it must prominently disclose how it is compensated in near proximity to this representation.
Additionally, an FDM may not represent that a customer will have direct access to the interbank market since the FDM is actually the counterparty to every customer's forex transition. Similarly, no FDM that utilizes straight-through processing can suggest that they are not the counterparty to a customer's trade.
Additionally, an FDM or an IB may not represent that it offers "no-slippage" or can guarantee fills unless it can demonstrate that all orders on its platform have been executed at the price initially quoted when the order was placed on the platform and it does not have the authority to adjust customer accounts so as to have the effect of changing the price at which the order was executed.
In other words, if an FDM "re-quotes" prices or has the contractual right to make adjustments that directly or indirectly change the price of an order after it is executed, it cannot claim to have no slippage. Any reference to hypothetical performance results that could have been achieved using your trading system must comply with NFA Compliance Rule c and the related Interpretive Notice as if the performance results were for on-exchange transactions.
Finally, promotional materials may never guarantee against loss. Members remain responsible for meeting their regulatory obligations in situations where they utilize or promote forex trading systems developed by third parties. Specifically, an FDM has direct responsibility for misleading promotional material if the FDM prepares or distributes it; has agency responsibility if the trading system developer is an agent of the FDM under established principles of agency law; and has supervisory responsibility if the Member fails to supervise its own employees in its activities with a third-party system developer.
Members must maintain all promotional material for five years from the date of last use and must keep it readily accessible for the first two years. Furthermore, Members must maintain supporting documentation for all statements, claims and performance results included in promotional materials. FDMs, and their Associates, may not exercise trading authority over a customer account for which the FDM is, or is offering to be the counterparty.
An FDM may not carry offsetting positions in a customer account and must offset the positions on a first-in, first-out basis. A customer may, however, direct the FDM to offset same-size transactions even if there are older transactions of a different size, but the transaction must be offset against the oldest transaction of that size. An FDM is prohibited from directly or indirectly canceling or adjusting the price of executed customer orders, with two exceptions.
The first exception is where the adjustment is done to settle a customer complaint in the favor of the customer. An FDM may also adjust orders even in the absence of individual customer complaints if the customer were adversely affected by a technical problem with the Member's trading platform. However, an FDM may not adjust prices on customer orders that benefitted from the error and may not cherry-pick which account to adjust. The second exception is where the FDM uses exclusively "straight-through processing" such that it automatically executes without human intervention and without exception an offsetting position to a customer order with another counterparty prior to providing an execution to the customer order.
An FDM that adjusts an executed customer order based on an adjustment by a counterparty must provide notice to the affected customer within fifteen minutes of the customer order having been executed. The notice must state that the Member intends to cancel or adjust the price of the order to reflect the adjusted price provided by the Member's counterparty and must include documentation of the cancelation or price adjustment from the counterparty.
The Member must either cancel or adjust all customer orders executed during the same time period and in the same currency pair or option regardless of whether they were buy or sell orders. All cancellations or adjustments of executed customer orders must be reviewed and approved in writing by a listed principal of the Member who is also an AP.
Such review must include the documentation from the counterparty and must be provided to NFA. Finally, any Member that may elect to cancel or adjust executed customer orders based upon liquidity provider price changes must provide customers with written notice of that fact prior to the time the customer first engages in forex transactions with the Member. In the context of FDM trading systems, price slippage sometimes occurs between the time a customer first submits an order and the time the order reaches the FDM's system.
When this occurs, some FDMs immediately requote the customer the current price and require the customer to confirm that it still wants to place the order at the requoted price. Other FDMs have built in slippage parameters that permit execution of the order if the slippage is within the established parameters. FDMs that use slippage parameters must apply the slippage settings uniformly regardless of the direction the market has moved. If the FDM requotes prices when the market moves against it, it must requote prices when the market moves in its favor.
FDMs are prohibited from permitting customers to fund their commodity interest accounts with a credit card or other electronic funding mechanisms that draw funds from a credit card. FDMs may accept customer deposits from electronic payment mechanisms that draw funds directly from a customer's account at a financial institution provided that the FDM is able to distinguish, prior to accepting funds, between an electronic funding method that draws funds from a customer's account at a financial institution and a traditional credit card, and be able to reject the credit card before accepting customer funds.
See Notice to Members I Each Member must maintain books and records necessary to conduct its business and FDMs must provide forex customers with timely and accurate notice of the status of their accounts. Account activity includes offsetting transactions, rollovers, deliveries, option exercise, option expirations, trades that have been reversed or adjusted, and monetary adjustments. In those cases where a customer's account had either no open positions at the end of the monthly statement or any changes to the account balance since the prior statement, the Member is must still provide a monthly statement at least once every three months.
Each FDM must, not later than the next business day after any retail forex or forex option transaction, furnish the retail customer with the following:. Upon the request of an FDM's customer with respect to a particular executed forex transaction of that customer, an FDM must provide the customer, within 30 minutes of the customer's request, with certain transaction data for the 15 forex transactions that occur immediately before and after in the same currency pair of the customer's transaction.
Members and their Associates that have supervisory responsibilities must diligently supervise the Member's forex business. This includes supervising the activities of the Member's employees and agents. The annual report must include a certification by the FDM's CCO or chief executive officer that to the best of his or her knowledge and reasonable belief, and under penalty of law, the information contained in the annual report is accurate and complete.
Members must establish, maintain, and enforce written supervisory procedures reasonably designed to detect and prevent violations of NFA rules. While these interpretive notices do not directly apply to forex transactions, the principles included in them are equally applicable to those transactions. NFA recognizes that, given the differences in the size and complexity of the operations of Members, there must be some degree of flexibility in determining what constitutes "diligent supervision" for each firm.
Firms should tailor their procedures to their unique circumstances as long as they meet certain minimum requirements. An adequate supervisory program includes on-site visits to branch offices and guaranteed IBs that conduct forex business on behalf of the Member. Your firm should consider the characteristics of the branch office or guaranteed IB when deciding how often to visit it and what the visit should cover. How formal the training program is will depend on the size of the firm and the nature of its business.
CFTC Regulation 5. The requirements also apply to an FDM that uses another entity's trading system through a "white-labeling" agreement. An FDM must adopt and enforce written procedures to address security, capacity, credit and risk management controls, recordkeeping, and trade integrity with regard to its electronic trading platform. Each year, a principal who is also registered as an AP of the Member must certify that the firm has met the relevant standards for their electronic trading system.
Members must protect the reliability and confidentiality of customer orders and account information, and the procedures must assign responsibility for overseeing the process to one or more individuals who understand how it works and who are capable of evaluating whether the process complies with the firm's procedures. Members must maintain adequate personnel and facilities for the timely and efficient delivery of customer orders and reporting of executions and for the timely and efficient execution of customer orders.
In addition, the procedures must be designed to handle customer complaints about order delivery, execution, and reporting and to handle those complaints in a timely manner. Members must have procedures reasonably designed to prevent customers from entering into trades that create undue financial risks for the Member or the Member's other customers. FDMs who have trading platforms that claim to automatically liquidate positions before an account goes into a deficit must set the automatic liquidation levels high enough so that positions will be closed out at prices that will prevent the account from going into a deficit position under all but the most extraordinary market conditions.
The Member's trading system must record and maintain essential information regarding customer orders and account activity. The Member's trading system must also produce daily exception reports showing price adjustments and orders filled outside of the price range displayed by the system when the customer order reached the platform. The Member should review these reports for suspicious or unjustifiable activity. The Member's trading system must also produce daily reports showing each price change on the platform, the time of the change to the nearest second, and the trading volume at that time and price as well as the method used to determine the price for any forex transactions.
Members must have in place procedures reasonably designed to ensure the integrity of trades placed on their trading platforms. Three areas of particular concern include the following:. A Member becomes responsible for these dues when it first offers to be a counterparty to a forex transaction or accepts a forex trade. Thereafter, NFA assesses dues on the firm's membership renewal date and will base them on the FDM's most recent certified financial statement.
An "order segment" is a record of any line of data associated with an order. Each of these is a separate segment: 1 an order is added, 2 an order is modified, and 3 an order is cancelled or filled. In addition, any unfilled open orders that are carried over by the system are considered a new order segment the next day. FDMs must collect security deposits from customers. These security deposits help protect FDMs against losses from defaulting customers and ECP counterparties, which, if significant enough, could cause an FDM to become insolvent and put the funds of its other, non-defaulting customers and ECP counterparties at risk.
The security deposit must be at least:. An FDM may not, however, decrease the required security deposit amount below the highest minimum security deposit amount as applicable to a particular currency under NFA Financial Requirements Section Additionally, an FDM is prohibited from acting as a counterparty to an ECP acting as a dealer unless that dealer  collects and maintains from its customers and ECP counterparties security deposit amounts for forex equal or greater to the amounts required by NFA Financial Requirements Section If the currency pair includes currencies with different security deposit requirements, the Member must collect the higher percentage amount.
Therefore, if the transaction pairs the U. For short options, the FDM must collect the security deposit plus the premium the customer received. For long options, the FDM must simply collect the entire premium from the customer. The FDM must calculate the security deposit when the positions are initiated and at least daily thereafter. The firm must make this daily calculation while customer positions are open. In other words, your firm may not calculate the security deposit while the positions are being rolled over if your firm treats its customers as flat during that period.
NFA requirements, however, do not prohibit FDMs from computing security deposits more than once a day. An FDM must collect additional security deposits from a retail forex customer, or liquidate the customer's positions, if the amount of the customer's security deposits maintained with the FCM is not sufficient to meet the requirements set forth above. See 2 c 2 D of the Act for a description of retail commodity transactions. Minimum financial requirements help protect customers and market participants by requiring Members to maintain enough capital to remain solvent and meet their financial obligations.
An affiliate is any person that controls, is controlled by, or is under common control with the FDM. An unregulated person is defined as any person that is not one of the following:. An FDM may not consider offsetting currency transactions or positions executed with or held by or through an affiliate or unregulated person for purposes of determining net currency positions and the required capital deductions under CFTC Regulation 1.
CFTC Regulation 1. Your firm's financial statements must be prepared according to generally accepted accounting principles GAAP. An independent public accountant must certify the financial statement prepared as of the firm's fiscal year end.
Although the Form 1-FR contains a number of different financial statements, only the applicable statements need to be prepared for each filing. The instructions for the Form 1-FR generally say where to classify items on the form. As a result, the form does not clearly indicate how to account for some items related to the forex activities of FDMs. FDMs should account for their forex activities on the Form 1-FR form as follows: On the asset side of the balance sheet, funds received from customers for forex transactions should be classified as "Retail Forex Aggregate Assets.
FDMs must take a capital charge on all uncovered proprietary positions, although the firm may net on-exchange and off-exchange positions when determining the firm's uncovered position. Uncovered off-exchange proprietary positions are subject to a haircut charge that depends on the underlying currency.
When calculating its net position, your firm may include foreign currency held in deposit, investment, or trading accounts at banks, FCMs, broker-dealers, and similar entities if the following conditions are met:. An FDM, however, may not include positions at an affiliate or an unregulated person when calculating its net position for purposes of the capital charge.
Proceeds from subordinated loan agreements may be included in the firm's capital if the agreement meets the requirements in CFTC Regulation 1. The firm must submit a signed copy of the agreement to its DSRO at least 10 days prior to the proposed effective date.
A subordination agreement must include the name and address of the lender, state the business relationship of the lender to the firm, and indicate whether the firm carried funds or securities for the lender at or about the time firm files the proposed agreement. If a lender contributes 10 percent or more of the firm's capital, then the firm must list the lender as a principal.
The Member must also submit amendments to existing subordination agreements to its DSRO for approval. You can obtain copies of these agreements from NFA's website. To calculate the amount owed, add up the net liquidating values of each forex account that liquidates to a positive number, using the fair market value for each asset other than open positions and the current market value for open positions. This signed agreement must be filed with NFA.
The qualifying institution must comply with this request in order to be deemed an acceptable qualifying institution to hold assets covering an FDM's liabilities to retail forex customers. Any FDM funds that are not held in a qualifying institution as noted may not be considered as part of assets covering liabilities to forex customers. FDMs are required to prepare and maintain ledgers or other similar records that summarize each transaction affecting the Member's assets, liability, income, expense and capital accounts and include appropriate references to supporting documents.
Generally, the firm's records would include basic accounting documents such as a General Ledger and a Cash Receipts and Disbursements Journal. In order to demonstrate compliance with the capital requirements, an FDM should make and maintain daily records showing the transactions executed that day and their effect on the firm's obligations to its customers. The record of daily trades should show, at a minimum, the date, time, currency pair, price, and size of each transaction; commissions and fees; and the person for whom the transaction was made.
For options, the record should include whether the option is a put or a call, the strike price, the delta, and the premium. The record of obligations to customers should include the gross profits and the gross losses to customers, the firm's open currency exposures to customers, the sum of the customers' cash balances, and the net liquidating value of all customer accounts combined.
The individuals responsible for preparing an FDM's books and records must be under the ultimate supervision of a listed principal and registered AP of the Member. Such principal is also responsible for researching and selecting the independent public accountant that certifies the firm's annual financial statements. The FDM must demonstrate that its system of internal controls provides reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.
The FDM must also demonstrate that its system of internal financial controls has no material weaknesses and that it is adequate for establishing and maintaining internal controls over financial reporting by the Member. An FDM may satisfy this obligation by obtaining an internal control report that is prepared and certified by an independent public accountant who is registered under Section of the Sarbanes-Oxley Act SOX.
The internal control report shall contain, at a minimum, a detailed explanation of the examination performed by the accountant and a representation by the accountant that it has examined and tested the FDM's system of internal controls and that the controls comply with the above standards.
If NFA believes that a Member's internal controls are inadequate at any time, NFA's Compliance department may require it to provide to NFA an internal control report that is prepared and certified by an independent public accountant who is registered under Section of the SOX. The internal control report shall meet the above standards. Each FDM must be able to properly account for all funds received from and owed to customers.
FDMs should prepare a daily computation showing the total amount of customer funds on deposit, the total amount of customer open positions, and the total amount due to customers. The firm must file with NFA three report types: daily electronic reports showing liabilities to customers and other financial and operational information; monthly operational and risk management reports; and quarterly reports that contain the most-recent performance disclosures required under CFTC Regulation 5.
The daily reports must be prepared each business day, and must be filed by noon on the following business day. The monthly reports must be filed within 17 business days after the end of each month for which the report is prepared. Similarly, the quarterly reports must be filed within 17 business days after the end of each quarter for which the report is prepared.
Submitting these reports certifies that the person filing it is a supervisory employee that is, or is under the ultimate supervision of, a listed principal who is also an NFA Associate, is duly authorized to bind the FDM, and that all information in the report is true, correct, and complete. Each FDM is required to establish, maintain and enforce a Risk Management Program designed to monitor and manage the risks associated with their forex activities.
Each FDM must have a supervisory system in place to ensure that the Risk Management Program is being diligently followed by all appropriate personnel. Each FDM must adopt written policies and procedures that describe the risk management program and those policies and procedures must be approved in writing by the firm's governing body.
The firm must also ensure that any materials changes to the policies and procedures are approved in writing by the firm's governing body. The Risk Management Program must include procedures for the timely distribution of the written Risk Management Program to relevant supervisory personnel. The FDM is required to maintain records of the persons whom the Risk Management Program is distributed to along with the date of distribution.
The RMU must have sufficient authority; qualified personnel; and financial, operational and other resources to carry out the firm's Risk Management Program. The RMU should report directly to the firm's senior management, and must be independent from those employees involved including in a supervisory capacity in pricing, trading, sales, marketing, advertising, and solicitation activities of the FDM collectively business trading unit.
The RMU also must provide to FDM senior management and its governing body quarterly written risk exposure reports, which set forth all applicable risk exposures of the FDM, breaches of any established risk limits, any recommended or completed changes to the Risk Management Program, the recommended time frame for implementing recommended changes; and the status of any incomplete implementation of previously recommended changes to the Risk Management Program.
An FDM must also immediately provide senior management and its governing body with an interim risk exposure report any time the FDM detects a material change in its risk exposure. The Risk Management Program must include policies and procedures to monitor and manage the following risks: market risk, credit risk, liquidity risk, foreign currency risk, legal risk, operational risk, counterparty risk, liabilities to retail forex customers risk, technological risk, capital risk, and any other applicable risk.
The Risk Management Program must set risk tolerance limits for each of these risks. The Risk Management Program must discuss the underlying methodology used in setting these limits; as well as any policies and procedures governing exceptions to these limits and detecting and reporting breaches to appropriate management. Each FDM's senior management on a quarterly basis and governing body on an annual basis should review and approve the risk tolerance limits.
The FDM's RMU must require the FDM to conduct stress tests under extreme but plausible conditions of all positions in the proprietary account and in each counterparty account both retail customers and ECPs at least on a semi-monthly basis. The review and testing should be conducted by qualified internal audit staff that are independent of the business trading unit, or by a qualified third party audit service, which reports to FDM staff that are independent of the business trading unit.
The review must include an analysis of adherence to, and the effectiveness of, the risk management policies and procedures, and any recommendations for modifications to the Risk Management Program. The results of the review must be reported to and reviewed by the FDM's senior management and governing body. The FDM must document all internal and external reviews, and testing of the Risk Management Program including the date of the review or test; the results; any identified deficiencies; the corrective action taken; and the date the corrective action was taken.
The FDM must maintain copies of all written policies and procedures, changes to the policies and procedures and all required approvals for the period required by CFTC Regulation 1. Each FDM must make the following information available on its website and must update the information as necessary to keep it accurate but at least on an annual basis:.
Federal law imposes significant anti-money laundering AML requirements on financial institutions, including Members. Members must establish and implement policies, procedures, and internal controls reasonably designed to assure compliance with AML provisions of the Bank Secrecy Act BSA and related regulations.
A firm's procedures must cover these key areas:. The AML program must include procedures to obtain information about the customer and to verify their identity. Unlike NFA's "know your customer" requirements, these requirements apply to all customers, not just individuals. A Member must obtain the following minimum information before it transacts business e.
In addition to obtaining this minimum information, the Member must take steps to verify the customer's identity. You do not have to verify the customer's identity before transacting business with the customer but must do so within a reasonable time before or after the first business transaction. The procedures for verifying the customer's identity should:.
If a Member cannot identify a customer that is not an individual using its normal procedures, the Member may need to obtain information about the individual with authority or control over the account. Your firm's customer identification procedures should describe those situations where the firm will obtain this information. Members are not required to determine whether a document used to verify identity is valid.
If a document appears to be a forgery or there is other evidence of fraud, however, your firm must decide whether it has enough information to form a reasonable belief that it knows the customer's true identity. The same is true if the information provided by the customer is inconsistent e. A Member may rely on another U. The law provides a safe harbor if the BSA requires the other financial institution to have an AML program, that financial institution enters into a contract with the Member agreeing to annually certify that it has implemented an AML program and will perform the required steps, and reliance is reasonable under the circumstances.
Your firm's procedures must describe any circumstances where it will rely on another financial institution. Although the safe harbor does not apply unless all of the above conditions are satisfied, firms may also choose to rely on U. Your firm should conduct a risk-based analysis before relying on those institutions.
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Foreign Exchange (forex or FX) is. In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying with some quantity of another currency. FOREX linked to transactions. Our trading room specialists offer tailor-made solutions for exchange issues that meet the needs of your business.