Although FX trading is legal in the US, the industry itself has not been as active. If you just count the number of FX agents who offer their services to US residents, the number is shockingly low compared to other regions of the world. In fact, there may even be more agents providing their services in Africa than there are in the US. This huge difference is due to the regulatory framework in the US that has kept the industry from growing. However, with a new administration in the US promising fewer regulations, people were hoping the industry would be revived. It would be thus interesting to learn about the current situation, the facts and the future trends. (FX in USA: Myth or Reality?)
What is the current situation regarding FX regulations in the US?
As it stands right now, the US FX market is very hostile to individual traders, which is why we have so few retail FX agents. Nevertheless, the US still serves 16% of the entire FX market according to the Bank for International Settlements (BIS) in 2016, showing that the industry is not completely dead. Instead, it is now mainly focused on institutional traders like hedge funds and investment banks to drive turnover. To understand why the US FX markets are so different, you have to consider the laws that are currently in place to control the industry. (When Choosing A FX Agent, Pick The One With Winning Clients)
Some of the laws currently governing the US FX markets
We have covered this topic extensively in the past here at Top Agents, so we don’t need to go into too much detail. All you need to know for now is that the FX industry as well as other financial markets received a major overhaul in 2010 following the implementation of the Dodd-Frank Act. This piece of legislation was meant to increase consumer protection, but it inadvertently made the financial markets inhospitable for FX agents. This lead to a massive exodus by the previously established agents out of the country from then on. Today, there are only a handful of agents left in the country and most offshore agents expressly decline to sign up clients based in the US. (These are the: Laws and limits of FX trading in the US)
The Dodd-Frank Act made retail trading more unfavourable to individuals because it introduced, among other changes:
- The abolition of hedging – hedging is useful when you want to limit your losses by placing an opposite trade to the one currently opened. For example, say you bought 1 lot of the EUR/USD but wasn’t sure about the FED’s decision on interest rates in the upcoming meeting, you could buy the USD/JPY just in case the value of the US dollar shot up. In so doing, you wouldn’t have to close your previous position on the EUR/USD even if it started to make a loss because the second position would make up for the difference (Concepts Every Trader Should Understand: Leverage, Margin and Hedging)
- Application of a FIFO policy – the first-in first-out (FIFO) policy dictates that you can’t open multiple positions on the same currency pair. You would need to first close the current position before opening another one. Sometimes it can be useful to open multiple positions on the same pair to essentially double down on a good trade. With a FIFO policy in place, though, this would mean extra costs incurred in the closing and opening of a position; not to mention other problems like slippage, spread, etc. (Learn: How to find best FX spreads)
- Low leverage cap – trading in the US limits the leverage at 50:1 for major currency pairs and 20:1 for exotic currency pairs. This is a lot lower than most other agents in Europe and Australia that offer up to 500:1 leverage. For individual traders without a lot of capital, a high leverage is essential for maximizing profits as it means more virtual capital to work with (This is: How to protect yourself from margin call)
These limitations kept many retail traders away from the FX markets because the conditions were just too restrictive, and they opted for FX agents located offshore. Of course, this is prohibited by the US FX regulators (NFA and CFTC) but some traders still did it. On the side of the agents, there were also some problems too. The first was the obvious lack of clients, which is how they make most of their revenue. Companies on the STP FX agents list make their money by charging a spread on every trade. Without regular traders to keep making these trades all day, the agents would not make as much money as they intended. (Do you know: How much money FX agents make?)
Moreover, agents considered the penalties in the US too punitive. The Dodd-Frank Act was passed as a deterrent to future unscrupulous activity by financial institutions whose financial products lead to the 2008 financial crisis. To be effective, financial institutions found to be doing anything wrong would be heavily fined or completely banned from operating. FXCM was one such broker who was kicked out of US markets after being discovered to be misrepresenting their services. The broker claimed to be running an ECN trade execution system, but it was discovered they were just using a dealing desk. Most popular FX ECN agents use a true ECN system, but this broker was actually lying and manipulating quotes. This cost them a $7 million fine and being barred from US markets. Most agents don’t make a lot of money and such huge fines could render a company broke, so to avoid them the agents just left the US markets. (Can You Actually Get Your Money Back From A Fraudulent Broker?)
Will these laws ever be changed?
As you would expect, many people were not happy about the Dodd-Frank Act, especially those in major financial institutions. This is why many of them were expecting major changes with the new administration. During his presidential campaign, Donald Trump promised to reduce the number of regulations surrounding various industries, including the financial sector. Indeed, he was quoted as saying he would “do a big number on Dodd-Frank”. Many people, including us, believed this would affect even the FX market if the industry regulations were repealed under the new administration. (Find out about the: Growth Of The FX Market In Africa And Other Developing Countries)
However, this has yet to happen after 2 years and hope may be dwindling with time. To be fair, President Trump has indeed rolled back a lot of regulations, they are just yet to impact the FX market. For example, Investor’s Business Daily reported that President Trump added 10% pages to the Federal Register in 2018 by increasing federal rules by 2%. This made Trump the best performer in reducing regulations compared to even Obama, Bush II and Clinton. You see, the problem is that one cannot just revoke rules, but rather write new ones. So, even if you intend to remove regulations, you will end up with just more rules to phase out the old ones. Trump managed to reduce the number of rules by promising to get rid of 2 rules for every new one he enacts. To truly roll back regulations faster, that would require an amendment to the 1946 Administrative Procedure Act that dictates how new rules are implemented. (In case: You Wanted To Know How Many Traders Lose, Now You Know)
One of the reforms made to the financial industry came last year. On the 22nd of May 2018, Congress rolled back a section of the Dodd-Frank Act that freed up smaller banks with less than $250 million in assets and credit unions. Prior to the rollback, these smaller banks were under heavy scrutiny that cost taxpayers billions and limited their activities. Now, they can more freely issue mortgages while at the same time saving taxpayers’ money. The approval to repeal a section of the Dodd-Frank Act was reached by a 258-159 vote in congress, but not everyone was happy about it. (Here is: Everything You Need To Know About The cTrader FX Trading Platform)
The argument by those who voted for the rollback was that the regular stress tests required even for small banks cost a lot of money. Additionally, by requiring credit scores for small loans, this could discriminate some people from getting loans. They argued that by removing some of these restrictions, the economy would become more vibrant than before. On the other hand, those opposed pointed out to the huge profits banks were making as a reason not to change the rules as they were doing just fine. Besides, they argued, these small banks were not the ones responsible for the financial crisis anyway. In the end, a partial repeal of the regulations was reached because even the Democrats saw some good in it. (Do you know: Which Are The Best Commodities To Trade In The Autumn?)
There are still more overhauls expected for the Dodd-Frank Act, but this may become more difficult this year. In last year’s midterm elections, the Republicans managed to keep the Senate, but lost the House to the Democrats. Since both of these houses have to agree before any reforms are made, it may become very difficult to make any more reforms this year. For the regulations to change to the extent that the FX market is finally freed from the restrictive measures would take a lot of time. Between the squabbles between the house and senate and the overall low priority the FX market plays in the US financial sector, we may have to wait several years to see any changes. You may also want to consider the fact that the next president may not be as inclined to repeal the financial act as Trump is. All in all, it’s unlikely there will be any changes to the FX market in the US any time soon. (How Do You Know An Expert Advisor Is Out Of Date?)
Changes to expect on FX decrees
Just because the decrees haven’t actually been passed does not mean we can’t try to predict some of the changes to expect if and when the reforms are made. Keep in mind, these are just speculative. One of the most impactful changes that came with the Dodd-Frank Act was a limitation of leverage down to 50:1 from highs of 500:1. For traders, this was just too huge of a decrease to take, and people opted out. Unfortunately, things have changed since then and many other FX regulators have also implemented limits on leverage. Last year, ESMA published its final report, placing a cap on leverage at 30:1 for major currency pairs and 20:1 for exotic pairs and major CFDs of commodities and indices. This is even lower than that enforced by the NFA and CFTC in the US! (These are: The Best FX Events And Expos To Attend Every Year)
That means people who were previously disinclined to trade with US FX brokers may actually go back to them. Furthermore, US FX brokers may even get clients from outside the US who see the ‘punitive’ decrees by the NFA as more favourable than those by ESMA. Knowing this, then it may actually be unlikely that the decrees governing FX trading in the US will even change at all. After all, these will be better than most others. Perhaps some traders will still be put off by the other restrictions by the US regulators, but these weren’t the main reasons for people to leave US brokers. Many of us could live with a lack of hedging and the FIFO policy just by taking more precautions in risk management. (ESMA Finally Puts Its Foot Down On MiFID II Decrees)
As for the brokers themselves, they will probably be the most enticed by the newly opened market. Among other changes in decree included a very high minimum capital requirement for banks and fiscal institutions. This was implemented to ensure that all fiscal institutions could handle any market fluctuations without going bankrupt. As previously mentioned, a lot of brokers don’t make a lot of revenue, nor do they have a lot of capital to reach the requirements in the US. These decrees are encapsulated within the Volcker Rule, which are being targeted for reform. The Volcker rule dictates the amount of capital institutions must have to make trades in the open market. If repealed, then the brokers would not need so much capital to operate in the US. (This is: Why FX Trading Should Not To Be Treated Like A Casino)
Remember that inasmuch as brokers depend on spreads and commissions to make money, they also use client deposits to participate in the open market. This is actually how they make the serious money, and the more they are allowed to leverage on clients’ deposits, the more they have to trade with other fiscal institutions. The Volcker rule currently limits these institutions by requiring a high leverage on clients’ deposits, hence why the companies also need a huge minimum capital to operate. (Are you planning to start trading: Think Twice When Making A Deposit In A FX Company)
We can see now that any reforms to the FX decrees in the US are bound to have a major impact to the industry, and that changes are bound to happen. Although the senate and house may disagree on many issues, it is already clear that deregulation is necessary. Economists have even attributed the rapid growth of the US economy under Trump’s administration by an estimated 3% to the rate of deregulation. Both houses of Congress see this too, and it is only a matter of time before major reforms to the FX market are made. The only question shall be whether these decrees will match those of the EU or not. Being the FX hub of the world, a lot of cues regarding decree are taken from ESMA and the FCA, so it is possible the CFTC and NFA will copy the path traced by the former.
As for the main topic question, there are no worries. FX trading is legal in the US but with a lot of rules and decrees. The industry may receive some reprieve in the years to come, but we just can’t be sure when this will happen.
In order to learn more about FX decrees and their impact on traders, how about first seeing how they affected traders in the EU once ESMA made some changes: