See in addition to the leverage and capital rules — that most brokers acknowledge are sensible even if they didn’t support them — requirements involving communicating with customers and registration may be more burdensome. The rules and the age of new media are intersecting on a difficult path. Brokers who operate trading forums and educational workshops online will have to monitor them closely and keep records on them up to five years. The National Futures Association (NFA) will need to pre-approve all of this material, which is fine when it is boiler plate instructional material but many of these webinars, podcasts and chat rooms are interactive and don’t follow a simple script.

From the NFA’s perspective this is going to be more difficult and require more staff to monitor all of this communication.

The feeling from many at the show was not so much anger over new regulations but fear of the unexpected. The new rules could have a big impact on the potential profitability of these firms and they may need to make some tough decisions. For their part, the NFA did a good job answering questions at an all day seminar on Saturday, but they could not answer all the questions because the answers are not known yet and much will be a matter of interpretation by regulators and auditors.

One forex broker said he was facing having to cut his staff in half depending on how the rules play out.

We do know that the number of forex dealers has already shrunk considerably due to the new rules. Perhaps some of those firms were undercapitalized and should not have been there, but putting businesses out of business should not be the goal of regulation and it would be a shame if the retail forex sector, one of the most dynamic growth industries of the last decade, is strangled instead of just being contained as was necessary.

It seemed awfully odd that just a month or so after the National Futures Association (NFA) instituted new tougher standards for forex, that the CFTC would propose something so different. The NFA, after all, is the agency who has dealt on the front lines with the forex problem. There has been a lot more continuity in the leadership and the staff of the NFA in recent years than at the CFTC yet the CFTC proposed a leverage standard 10X more restrictive than the NFA rules that had just gone into affect.

 At the time we spoke to some experts who figured the CFTC was using the 10-1 leverage level as bargaining chip to soften some of the other elements. The final rules are a much less restrictive, setting leverage of 50-1 for the major currency pairs, but there is some question of whether U.S. traders will be able to access non U.S. forex dealers. Many traders are still unhappy and although leverage of 50-1 seems reasonable, there is still dissatisfaction and a feeling that the new regime will be more active and knows better that the folks they are regulating. We hope that is not the case because retail traders are not the problem. They, at times, have been the victim of forex fraud and that is what clearly defining a regulatory scheme for forex is supposed to do .

As we noted when the original rules were proposed, “While lower leverage may be prudent, requiring traders to use prudence is not the role of the regulator. That is what margin calls are for. The main role of the regulator is to ensure fair markets. The retail public does not need a regulator to be a nag, protecting them from risky behavior — people will select the risk level appropriate to them — they need a regulator to ensure a fair market place.”

 It is positive that the CFTC appears to have listened to the industry who overwhelmingly rejected the original proposal but it seemed that it needed to set a somewhat more restrictive measure in order to save face. However, for them to propose something so different that their fellow futures regulator–we know that FINRA has proposed much more restrictive leverage levels–in the first place is still hard to understand unless they were trying to make a statement. And as we noted, their focus was in the wrong place.

The measure of the new rules will be how affective the CFTC is at ferreting out the bad actors in the forex space, not if less traders bust out due to over leveraging positions.

China, which is still a major driver for worldwide economic growth, could come to the rescue, however. Forex.com reports that “additional fiscal stimulus in China may be a salvation to global recovery.” The report also says interest rates in the U.S., U.K., Eurozone and Japan will remain on hold into 2011 and that oil should weaken on excess supply and stalling demand.

Forex.com says key market themes for 2Q 2010 include prevailing choppy, range-bound short-term trading conditions; continuing Eurozone/UK credit concerns causing the euro to be under pressure and the pound to weaken;  a weaker yen on Bank of Japan rate easing and the likelihood of outperformance by the Canadian and Australian dollars. Forex.com analysts also say China’s efforts to restrain its economy are a “major risk to global economic recovery.” As for the U.S. dollar, they say it will benefit on growth divergence, increased risk appetite and speculation that the Fed will raise interest rates. “We expect the U.S. recovery to outpace other industrialized economies, likely lending the dollar support and keeping pressure on the euro, the pound and the yen,” said Forex.com Chief Currency Strategist Brian Dolan in the report.

Our experts will offer up a complete forex outlook in Futures April issue, on newsstands and online March 26. The issue also includes our Traders View of the World feature, for which we traveled to Washington to talk with Congress, the CFTC and other insiders about how new regulatory proposals could rock the trading universe.

Of course there was the increase in financial requirements for futures commission merchants (FCM) and retail forex exchange dealers (RFED), which was upped to $20 million, plus 5% of the amount, “if any, by which liabilities to retail forex customers exceed $10 million.” There was the new boilerplate disclosure rules, as well as the new required registration of FCMs and RFEDs and their associated persons. These were all expected and huffed about, but accepted as a way to keep OTC forex for retail open in a period where on-exchange has become the new black. What wasn’t expected was the leverage rule, that is, leverage in retail forex customer accounts would be subject to a 10-to-1 limitation. This would be far different than the current 100-1 level that just went into effect last year.

To put this in perspective, if you wanted to trade a contract of $100,000, today you need only $1,000 in your account. With the 10-1 rules, you would need $10,000. This basically raises the margin level from 1% to 10%. In comparison, the National Futures Association (NFA) required a 100-1 limit. A futures exchange contract can vary in leverage from 20-1 to 50-1 per contract, depending on currency and volatility (see Trendlines).

The anger from the RFEDs and FCMs was loud and clear: they will be out of business or have to flee to kinder regulatory shores if this proposal passes. Their customers were more blunt: try prying 100-1 leverage from their cold, dead hands. Seriously, in reading through of the comment letters thus far, this rule has taken on a Tea Party-esque aura in which people are ready to pick up arms to defend their right to trade. Here are some examples from comment letters:

“This country is supposed to be run ‘by the people’ which is a concept that seems to have been lost since 1776. Our forefathers would be appalled if they could see what is happening to their country – they wouldn’t recognize it as every day we lose a little more freedom.”

Or: “As an investor and active retail forex trader, I expect the freedom and right to choose the amount of leverage that is appropriate for my desired risk…”

Or: “Last summer the NFA ‘tweaked’ things…and now it’s as though Pandora’s Box has been opened so you too have to get in and change something that has been fine for 20 years.”

Or: “On the subject of regulating retail forex, plain and simple…STAY OUT OF TRYING TO RUN MY PERSONAL LIFE!!!!!!”

And another: “You are out of your cotton-pickin’ mind. I want to know the name of the communist who has proposed this legislation…..”

In fairness, although all the comments were passionate, most were reasonable, stating how this 10-1 ruling would affect their business and personal trading. Many thought the earlier reduction to 100-1 from 200-1 was acceptable, but this had taken it too far and would either force them to move off shore or quit trading OTC forex.

The day the rule was proposed, I ran into someone in the business who has his finger on the pulse of regulation. He shook his head when I asked how the CFTC came up with 10-1. “I don’t have any idea,” he said. “Seems like they pulled it out of the air.” Or from somewhere else, or so OTC retail traders would say.

She says with the current proposal there’s the potential to damage legitimate traders and that killing the market would not solve the fraud problem.

Daniel Waldman, partner at Arnold & Porter LLP and former general counsel at CFTC, says that although it’s uncertain what form pending legislation will take, that regulatory changes ARE coming. He says that the bottom line is that we will see new legislation and traders, therefore, need to follow developments on the regulatory front.

Brown-Hruska agrees, saying that the trading community “needs to make their voice heard” as new regulations are set to change the way they do business.

For more from our Washington insiders, including background and details on pending legislation, check out our feature story in the April issue.

House Agriculture CommitteeChairman Collin Peterson (D-MN), whose Peterson-Frank Amendment to HR 4173, passed by the House in December, established a central clearing requirement for OTC derivatives, says, “the way our legislation is crafted right now, you will see a lot of [OTC products] standardized, 70%-80% of this stuff will be standardized.” He mentioned how the House Ag Committee is working with European regulators and that CFTC Chairman Gary Gensler is focused on coming out with harmonized international regulation. 

Peterson  doesn’t believe position limits will force trading overseas and said big banks should be subject to the same position limits as speculators. In response to traders who say new regulations could impede the way they do business, he said, “it will affect the way they do business, and it should. Our economy got built up based on all of this money, and it was a false economy, and now we’re getting down to a real economy. To get to the real economy, it’s going to mean less business [for traders and banks]. They’ll survive.” He says OTC market regulation was the most important regulatory issue at the moment, along with making sure banks have adequate collateral. “The OTC market is so huge and it’s got to be brought out in the open.”

Next, we talked with CFTC Commissioner Jill Sommers about the issue that’s come under much criticismfrom the forex industry, CFTC’s recent proposal to reduce leverage for OTC forex firms to 10:1. “We don’t have a response yet; that’s the purpose of putting it out for comment. We’ve been working on this proposal for a number of months.” Obligations for CFTC to write rules in this area came in May of 2008 with the passage of the Farm Bill. “When you put a proposal out for comment, there’s always going to be parts of the proposal that the industry has concerns about and that’s the purpose of putting something out for comment.” Staff will review comments and will come to Commission with analysis of views and recommendations for a final rulemaking. She says final rulemaking is “several months away.” The comment period ends March 22. Sommers also said that she “does not have knowledge” about how the CFTC arrived at the 10:1 leverage calculation.

Stay tuned for reaction from Washington insiders including former CFTC Chairman Sharon Brown-Hruska, and for our larger feature on regulation, coming up in the April issue.

Adam Boyton, G10 FX Strategist for Deutsche Bank, discussed this along with other factors driving forex markets on a conference call Tuesday afternoon.  

Among Boyton’s observations was that equity markets have priced in too much of a recovery, despite pressure the dollar will remain the preeminent reserve currency for at least another five years and that interest rate differentials will no long be a primary driver of forex markets. “[The market] will look at interest rate differentials, but not as much as before,” Boyton said.

This concurred with comments made by Jamie Charles during taping of the Futures I-Trade Show trader profile to be aired tomorrow at noon CDT. Charles, CEO and portfolio manager of Greenwave Capital Management, discusses some of the changing dynamics in forex markets, stating that with the all the major currencies having an interest rate of 1% or below, interest rate differential will take a back seat to other  fundamental factors.

While Boyton states that the traditional carry trade as we know it is largely dead, there is an opportunity to profit from a new carry trade going long the Brazilian real and using traditional higher yielding commodity currencies like the Australian dollar, New Zealand dollar and Canadian dollar as the funding currency.

The reason commodity currency pairs like the BRL/AUD, BRL/NZD, and BRL/CAD, are a better option for carry trades is they have a low correlation to equity markets.  Using Japanese yen or the U.S. dollar as a funding currency means a higher correlation to equities according to Boyton.