[Federal Register Volume 78, Number 136 (Tuesday, July 16, 2013)]
[Rules and Regulations]
[Pages 42439-42451]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2013-17015]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-69964; File No. S7-30-11]
RIN 3235-AL19
Retail Foreign Exchange Transactions
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Commission is adopting a rule to permit a registered
broker-dealer to engage in a retail forex business, provided that the
broker-dealer complies with the Securities Exchange Act of 1934, the
rules and regulations thereunder, and the rules of the self-regulatory
organization(s) of which the broker-dealer is a member insofar as they
are applicable to retail forex transactions. The Commission is adopting
Rule 15b12-1 substantially in the form previously adopted as an interim
final temporary rule and is providing that the rule will expire on July
31, 2016.
DATES: This rule is effective from July 16, 2013 through July 31, 2016.
FOR FURTHER INFORMATION CONTACT: Catherine Moore, Senior Special
Counsel; Shaheen Haji Zuver, Special Counsel; or Stephen J. Benham,
Attorney-Adviser, at (202) 551-5550 or Division of Trading and Markets,
Securities and Exchange Commission, 100 F Street NE., Washington, DC
20549-7010.
SUPPLEMENTARY INFORMATION: The Commission is adopting Rule 15b12-1
under the Exchange Act, to permit a registered broker or dealer
(``broker-dealer'') to engage in retail forex transactions, as such
transactions are defined below. Unless the Commission acts further, the
rule will expire and no longer be effective on July 31, 2016.
I. Background
A. Retail Foreign Exchange
The foreign currency exchange (``forex'') market is a large and
liquid market used by banks, insurance companies, large corporations,
and other large financial institutions to trade in risks associated
with fluctuations in foreign currency rates. In recent years, a
secondary off-exchange market for forex has developed for retail
customers.\1\ Many customers may view forex as a possible investment
opportunity or portfolio risk management strategy. However, the
Commission, its staff,\2\ and other regulatory authorities \3\ have
cautioned investors that the forex market poses risks for retail
customers.
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\1\ See, e.g., FINRA Regulatory Notice 08-66 (Retail Foreign
Currency Exchange) (November 2008) available at: http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p117362.pdf (``FINRA Forex Notice'').
\2\ See Investor Bulletin: Foreign Currency Exchange (Forex)
Trading for Individual Investors (July 2011), available at http://www.sec.gov/investor/alerts/forextrading.pdf (``Forex Bulletin'').
See also Retail Foreign Exchange Transactions, Exchange Act Release
No. 64874 (July 13, 2011), 76 FR 41676 (July 15, 2011) (``2011
Interim Rule Release'') at 41677 (noting that media reports have
highlighted potential abuses).
\3\ See, e.g., Press Release, Commodities Futures Trading
Commission (``CFTC''), CFTC Releases Final Rules Regarding Retail
Forex Transactions (Aug. 30, 2010) (available at http://www.cftc.gov/PressRoom/PressReleases/pr5883-10.html?dbk) (noting
that retail forex is the largest area of retail fraud that the CFTC
oversees).
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The regulatory oversight of the retail forex market has developed
primarily through a series of amendments to the Commodity Exchange Act
(``CEA'').\4\ Transactions commonly referred to as ``retail forex
transactions'' are foreign exchange transactions with persons who are
retail customers (persons who are not eligible contract participants
(``ECPs'') as defined in the CEA) and that settle on a T+3 or greater
timeline.\5\ Significantly, certain types of transactions are not
``retail forex transactions'' under the CEA, even where one of the
counterparties is a person that is not an ECP. These transactions
include: (i) ``spot forex transactions'' where one currency is bought
for another and the two currencies are exchanged within two days; (ii)
forward contracts that create an enforceable obligation to make or take
delivery, provided that each counterparty has the ability to deliver
and accept delivery in connection with its line of business; and (iii)
options that are executed or traded on a national securities exchange
registered pursuant to section 6(a) of the Exchange Act.\6\ In
addition, and as discussed in more detail below, conversion trades--
trades in which a foreign exchange transaction facilitates the
settlement of a foreign security transaction--are spot forex
transactions and, therefore, are outside the scope of the CEA
prohibition and this rulemaking.\7\
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\4\ See Regulation of Off-Exchange Retail Foreign Exchange
Transactions and Intermediaries, 75 FR 3282 (Jan. 20, 2010) (``CFTC
Proposing Release'') for a detailed discussion by the CFTC of the
amendments to the CEA regarding retail forex.
\5\ See 7 U.S.C. 2(c)(2)(B)(i).
\6\ See 7 U.S.C. 2(c)(2)(B)(i)(I).
\7\ See Further Definition of ``Swap,'' ``Security-Based Swap,''
and ``Security/Based Swap Agreement''; Mixed Swaps; Security/Based
Swap Agreement Recordkeeping; Final Rule, Exchange Act Release No.
67453 (July 18, 2012), 77 FR 48207 (Aug. 13, 2012) (``Products
Definitions Release'').
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Only certain regulated entities may act as counterparty to foreign
exchange transactions.\8\ These approved entities include Futures
Commission Merchants (``FCMs''), Retail Foreign Exchange Dealers
(``RFEDs'') registered with the CFTC, banks, and insurance companies,
as well as broker-dealers registered with the Commission.
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\8\ 7 U.S.C. 2(c)(2)(B)(i).
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The Dodd-Frank Wall Street Reform and Consumer Protection Act
(``Dodd-Frank Act'') further amended the CEA to limit potential abuses
in the retail forex market by prohibiting retail forex transactions as
of July 16, 2011, in the absence of a rulemaking permitting retail
forex transactions by the relevant Federal regulatory agency. The
prohibition in the CEA applies to retail forex transactions with
registered broker-dealers, and the Commission adopted an Interim Final
Temporary Rule on July 13, 2011 (``Interim Rule''), to allow retail
forex transactions with broker-dealers under terms and conditions
prescribed by the Commission.\9\
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\9\ See 2011 Interim Rule Release. See also Extension of Interim
Final Temporary Rule on Retail Foreign Exchange Transactions,
Exchange Act Release No. 67405 (July 11, 2012), 77 FR 41671 (July
16, 2012) (``2012 Extension Release'').
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B. Amendments to the Commodity Exchange Act
As amended by the Dodd-Frank Act,\10\ the CEA provides that a
person for which there is a Federal regulatory agency,\11\ including a
broker-dealer registered under section 15(b) (except pursuant to
paragraph (11) thereof) or 15C of the Exchange Act,\12\ shall not enter
into, or offer to enter into, a transaction described in section
2(c)(2)(B)(i)(I) of the CEA with a person who is not an ECP,\13\ except
pursuant to
[[Page 42440]]
a rule or regulation of a Federal regulatory agency allowing the
transaction under such terms and conditions as the Federal regulatory
agency shall prescribe (``retail forex rule'').\14\ An individual can
qualify as an ECP if the individual has aggregate amounts invested on a
discretionary basis of more than $10 million or more than $5 million if
such individual enters into the transaction in order to manage the risk
associated with an asset owned or liability incurred, or reasonably
likely to be owned or incurred by such individual.\15\ Transactions
described in CEA section 2(c)(2)(B)(i)(I) include ``an agreement,
contract, or transaction in foreign currency that . . . is a contract
of sale of a commodity for future delivery (or an option on such a
contract) or an option (other than an option executed or traded on a
national securities exchange registered pursuant to section 6(a) of the
Securities Exchange Act of 1934 (15 U.S.C. 78f(a)).'' \16\ A Federal
regulatory agency's retail forex rule must treat all agreements,
contracts, and transactions in foreign currency described in CEA
section 2(c)(2)(B)(i)(I) and all agreements, contracts, and
transactions in foreign currency that are functionally or economically
similar to agreements, contracts, or transactions described in CEA
section 2(c)(2)(B)(i)(I), similarly.\17\ Any retail forex rule also
must prescribe appropriate requirements with respect to disclosure,
recordkeeping, capital and margin, reporting, business conduct, and
documentation, and may include such other standards or requirements as
the Federal regulatory agency determines to be necessary.\18\
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\10\ 7 U.S.C. 2(c)(2)(E).
\11\ 7 U.S.C. 2(c)(2)(E)(i), as amended by Sec. 742(c) of the
Dodd-Frank Act, defines a ``Federal regulatory agency'' to mean the
CFTC, the Securities and Exchange Commission, an appropriate Federal
banking agency (as defined in section 3(q) of the Federal Deposit
Insurance Act (12 U.S.C. 1813(q))), the National Credit Union
Association, and the Farm Credit Administration.
\12\ 7 U.S.C. 2(c)(2)(B)(i)(II).
\13\ ``Eligible contract participant'' is defined in CEA section
1a(18), as re-designated and amended by section 721 of the Dodd-
Frank Act. See Public Law 111-203, Sec. 721 (amending CEA section
1a). The CEA's definition of ECP generally comprises regulated
persons; entities that meet a specified total asset test (e.g., a
corporation, partnership, proprietorship, organization, trust, or
other entity with total assets exceeding $10 million subject to
certain restrictions) or an alternative monetary test coupled with a
non-monetary component (e.g., a corporation, partnership,
proprietorship, organization, trust, or other entity with a net
worth in excess of $1 million and enters into an agreement,
contract, or transaction in connection with the conduct of the
entity's business or to manage the risk associated with an asset or
liability owned or incurred or reasonably likely to be owned or
incurred by the entity in the conduct of the entity's business);
certain employee benefit plans, the investment decisions of which
are made by one of four enumerated types of regulated entities; and
certain governmental entities and individuals that meet defined
thresholds. The Commission and the CFTC adopted rules under the CEA
that further define ``eligible contract participant'' with respect
to transactions with major swap participants, swap dealers, major
security-based swap participants, security-based swap dealers, and
commodity pools. See Exchange Act Release No. 66868 (Apr. 27, 2012),
77 FR 30596 (May 23, 2012).
\14\ 7 U.S.C. 2(c)(2)(E)(ii)(I). As used in this release,
``retail forex rule'' refers to any rule proposed or adopted by a
Federal regulatory agency pursuant to section 742(c)(2) of the Dodd-
Frank Act. On September 10, 2010, the CFTC adopted a retail forex
rule for persons subject to its jurisdiction. See Regulation of Off-
Exchange Retail Foreign Exchange Transactions and Intermediaries, 75
FR 55410 (September 10, 2010) (``CFTC Final Rule''). The CFTC had
proposed its rules regarding retail forex transactions prior to the
enactment of the Dodd-Frank Act. See CFTC Proposing Release. The
Federal Deposit Insurance Corporation (``FDIC''), the Office of the
Comptroller of the Currency (``OCC''), and the Board of Governors of
the Federal Reserve System (``Board'') have adopted similar rules.
See Retail Foreign Exchange Transactions, 76 FR 40779 (July 12,
2011) (``FDIC Final Rule''); Retail Foreign Exchange Transactions,
76 FR 41375 (July 14, 2011) (``OCC Final Rule''); and Retail Foreign
Exchange Transactions, 78 FR 21019 (April 9, 2013) (``Board Final
Rule'').
\15\ 7 U.S.C. 1a(18)(A)(xi).
\16\ 7 U.S.C. 2(c)(2)(B)(i)(I).
\17\ 7 U.S.C. 2(c)(2)(E)(iii)(II).
\18\ 7 U.S.C. 2(c)(2)(E)(iii)(I).
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This amendment to the CEA took effect on July 16, 2011.\19\ As of
that date, broker-dealers, including broker-dealers also registered
with the CFTC as FCMs (``BD-FCMs''),\20\ for which the Commission is
the Federal regulatory agency could no longer engage in retail forex
transactions except pursuant to a rule adopted by the Commission.\21\
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\19\ See Public Law 111-203, Sec. 754.
\20\ See 7 U.S.C. 2(c)(2)(B)(i)(II)(cc), 2(c)(2)(C)(i)(I)(aa)
and 2(c)(2)(E). Congress expressly provided that the CFTC has
jurisdiction over an FCM's retail foreign exchange activities only
if the FCM is not also a registered broker-dealer.
\21\ See 7 U.S.C. 2(c)(2)(B)(i)(II) and 7 U.S.C.
2(c)(2)(E)(ii)(I). This prohibition does not apply to (1) forex
transactions with a customer who qualifies as an ECP, or (2)
transactions that are spot forex contracts or forward forex
contracts irrespective of whether the customer is an ECP. However,
consistent with other Federal regulatory agencies' retail forex
rules, Rule 15b12-1 applies to ``rolling spot'' transactions in
foreign currency by broker-dealers. See section II.A. below for a
description of rolling spot transactions.
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C. The Interim Rule
On July 13, 2011, the Commission adopted the Interim Rule (Rule
15b12-1T), which allows a registered broker-dealer to continue to
engage in, or enter into, a retail forex business until July 16, 2012,
provided that the broker-dealer complies with the Exchange Act, the
rules and regulations thereunder, and the rules of the self-regulatory
organization(s) (``SRO'') of which the broker-dealer is a member,
insofar as they are applicable to retail forex transactions.\22\ The
Interim Rule was designed to provide an opportunity for the public to
submit comments regarding broker-dealer practices in this area, which
would inform the Commission's consideration of what additional rules
may be necessary to address investor protection concerns, including
abusive sales practices, volatility, and riskiness of the forex market
as they affected the regulatory treatment of retail forex transactions
by broker-dealers. We explained at the time that our action was also
intended to preserve potentially beneficial market activity that, for
example, may serve to minimize a retail customer's exposure to the risk
of changes in foreign currency rates in connection with the customer's
purchase or sale of a security. We also described potentially abusive
practices, such as lack of disclosure about fees and forex pricing and
insufficient capital or margin requirements, and requested comment on
these practices and whether there are any steps we should take to seek
to prevent them in the 2011 Interim Rule Release.\23\ In July 2012, the
Commission extended the Interim Rule to July 16, 2013.\24\
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\22\ See 2011 Interim Rule Release.
\23\ See 2011 Interim Rule Release at 41684. The Commission's
Office of Investor Education and Advocacy published an Investor
Bulletin providing information about retail forex investing,
including information about the risks involved in that type of
trading. See Forex Bulletin. The CFTC and the North American
Securities Administrators Association also have published an alert
regarding risks of fraud in foreign exchange markets. See Foreign
Exchange Currency Fraud: CFTC/NASAA Investor Alert, available at
http://www.cftc.gov/ConsumerProtection/FraudAwarenessPrevention/ForeignCurrencyTrading/cftcnasaaforexalert.
\24\ See 2012 Extension Release.
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D. Interpretation Regarding ``Conversion Trades''
The Interim Rule was intended, in part, to address concerns that
broker-dealers would be precluded from entering into foreign exchange
transactions on behalf of retail customers in order to facilitate the
customer's purchase or sale of a security listed on a foreign exchange
and denominated in a foreign currency (``conversion trades'').\25\
Subsequent to the initial adoption and most recent extension of the
Interim Rule, in August 2012, the CFTC issued an interpretation in a
joint rulemaking with the Commission that conversion trades are not a
form of retail forex transaction subject to the prohibition under the
CEA.\26\ Under this interpretation, broker-dealers are permitted to
engage in conversion trades without a rulemaking by the Commission and
the level of broker-dealer foreign exchange activity subject to the
prohibition in section 2(c)(2)(E)(ii)(I) of the CEA (and
[[Page 42441]]
this rulemaking) is significantly reduced.
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\25\ See Memorandum from P. Georgia Bullitt, Morgan Lewis, on
Pershing LLC--Proposed Relief regarding transactions in Retail
Foreign Exchange to James Brigagliano et al. (June 17, 2011)
(available at http://www.sec.gov/comments/other/other-initiatives/otherinitiatives-56.pdf ).
\26\ See Products Definitions Release. For purposes of the
interpretation, a conversion trade is a transaction for the purchase
or sale of an amount of foreign currency equal to the price of a
foreign security with respect to which (i) the security and related
foreign currency transactions are executed contemporaneously in
order to effect delivery by the relevant securities settlement
deadline and (ii) the actual delivery of both the foreign currency
and securities occurs by the deadline.
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Although the CFTC interpretation excludes conversion trades from
the definition of retail forex, hedging and speculative trading in
foreign currency (other than bona fide spot transactions \27\) are
still within the scope of the definition. Broker-dealers, including BD-
FCMs, are therefore prohibited from engaging in such trades absent a
Commission rule.
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\27\ See Products Definitions Release at 48257. The Commission
and the CFTC consider a foreign exchange transaction that is entered
into solely to effect the purchase or sale of a foreign security to
be a bona fide spot transaction where certain conditions are met.
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E. Comments
The Commission received 20 comments on the Interim Rule.\28\
Sixteen comment letters were received on the Interim Rule after it was
adopted in 2011. Four comment letters (from only two commenters) were
received following the extension of the Interim Rule in 2012. To
provide a broad overview of both investor and industry reaction to the
Interim Rule, all of the comments received are addressed below.
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\28\ The comments are available at http://www.sec.gov/comments/s7-30-11/s73011.shtml.
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Nine commenters asked the Commission to preserve their ability to
engage in retail forex transactions.\29\ Another group of commenters
urged the Commission to adopt a final rule based on the approach
followed in the Interim Rule.\30\ These commenters maintained that it
is in the best interest of retail customers to have the opportunity to
conduct forex activity as part of their broader investing activity,
through their broker-dealers, with the assistance of personnel with
forex expertise.
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\29\ See email comments from Raul Gonzalez, dated July 17, 2011,
James Peck, dated July 17, 2011, Bob Flowers, dated July 17, 2011,
James M. Beatty, dated July 17, 2011, Angela Li, dated July 17,
2011, Mark A. McDonnell, dated July 21, 2011, Mark Smith, dated July
23, 2011, John Baur, dated July 27, 2011, and Ronald Covington,
dated October 23, 2011.
\30\ See Letter from Kenneth E. Bentsen, Jr., Executive Vice
President Public Policy and Advocacy, SIFMA and Robert Pickel,
Executive Vice Chairman, ISDA, to Elizabeth Murphy, Secretary,
Commission, dated October 17, 2011 (``SIFMA/ISDA Letter''). See also
Memorandum from SIFMA and ISDA to Marc Menchel, Gary Goldsholle,
Matthew Vitek, Rudy Verra, Glen Garofalo, FINRA, dated February 23,
2012. These commenters requested that the Commission clarify that
the Commission's rule, together with FINRA regulation, would
exclusively govern the retail foreign exchange activity of all
broker-dealers, including BD-FCMs. The Commission notes that the
rule being adopted, Rule 15b12-1, by its terms applies in the
context of retail forex transactions but does not alter the
requirement to comply with applicable Commission rules or other
rules in other contexts. These commenters also requested that the
Commission, in consultation with the CFTC, provide a safe-harbor to
broker-dealers that would apply in the event that the status of a
customer that is a natural person (including their investment
vehicles and family offices) changes from that of a retail customer
when a foreign exchange transaction is first entered into with the
broker-dealer, including a BD-FCM, to that of an ECP, because of
fluctuations in net assets, a change in market prices or other
factors. However, given that interpretations regarding what
constitutes a retail forex transaction are under the CEA and
therefore subject to the jurisdiction of the CFTC and not the
Commission, these commenters may wish to consider addressing this
request to the CFTC.
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One group of commenters limited their comments to conversion trades
and, as discussed above, asked the CFTC and other Federal regulatory
agencies (including the Commission), to take the view that conversion
trades are not prohibited for purposes of section 2(c) of the CEA.\31\
As noted above, the CFTC has issued an interpretation that conversion
trades are not retail forex transactions subject to the prohibition
under the CEA.
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\31\ See Letter from Phoebe A. Papageorgiou, Senior Counsel,
American Bankers Association and James Kemp, Managing Director,
Global Foreign Exchange Division, to Thomas J. Curry, Comptroller,
OCC, Robert E. Feldman, Executive Secretary, FDIC, Jennifer J.
Johnson, Secretary, the Board, David Stanwick, Secretary, CFTC, and
Elizabeth Murphy, Secretary, Commission, dated April 18, 2012
(``ABA/GFMA Letter''). See also SIFMA/ISDA Letter. SIFMA and ISDA
requested that the Commission amend the definition of ``retail forex
business'' in section (a) of Rule 15b12-1T in order to make clear
that conversion trade transactions would be permitted under the
Interim Rule, which is no longer necessary as a result of the CFTC's
interpretation.
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One commenter stated that the Commission should rescind the rule
and allow the statutory ban to take effect or, in the alternative,
limit the scope of the rule to a narrowly defined class of forex
transactions, specifically hedging and the facilitation of settlement
of foreign securities.\32\ The commenter further stated that in
initially adopting the Interim Rule, the Commission did not provide
notice of and opportunity for comment on the rule, and did not include
a concrete assessment or quantification of the need for the relief
granted by the rule. As discussed throughout this release, the
Commission does not believe it would be appropriate at this time to ban
retail forex transactions or otherwise limit the scope of permissible
transactions by broker-dealers. Such a ban or limitation may prohibit
legitimate activities such as hedging or other transactions and, among
other factors discussed below, the Commission has not obtained
sufficient information to indicate that such restrictions are
warranted. In addition, the final rule we are adopting today is being
adopted after notice and comment in response to the 2011 Interim Rule
Release and the 2012 Extension Release.
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\32\ See Letter from Dennis M. Kelleher, President and CEO, and
Stephen W. Hall, Securities Specialist, Better Markets, Inc. to
Elizabeth Murphy, Secretary, Commission, dated September 12, 2011
(``Better Markets Letter''). We understand the commenter's reference
to transactions entered into to facilitate the settlement of foreign
securities to mean the conversion trades discussed above that are no
longer subject to the statutory prohibition.
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Three comment letters provided the Commission with data on retail
forex activity. One of the commenters provided data, based on a
sampling of five broker-dealers for an unknown year, showing that those
members engaged in $550 million per month (principal) of over-the-
counter currency forwards, currency options and rolling spot
transactions with non-ECPs and $1.2 billion per month of conversion
trades.\33\
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\33\ See Letter from Kenneth E. Bentsen, Jr., Executive Vice
President Public Policy and Advocacy, SIFMA, dated July 10, 2012
(``SIFMA Letter'').
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The second comment letter provided data on the returns of retail
forex accounts at certain FCMs and RFEDs, and offered suggestions for
additional disclosure and business conduct requirements (such as
suitability standards), and identified areas concerning regulation and
market activities in the context of retail forex transactions that the
commenter believed warrants further monitoring.\34\ We agree with the
commenter's suggestion that further monitoring of retail forex
transactions is warranted. While the Commission has determined to adopt
Rule 15b12-1 for the reasons discussed throughout this release, we
believe it is appropriate to give additional consideration to the
suggestions provided by the commenter. We are including in Rule 15b12-1
a provision providing that the rule will expire on July 31, 2016 to
permit additional time for the Commission to assess the market for
retail forex (including recent regulatory developments discussed below)
and potentially develop more targeted rules for retail forex or to
consider any rules that an SRO may propose regarding its members'
retail forex activities. The commenter also suggested that currency
exchange-traded funds (``currency ETFs'') would provide an alternative
[[Page 42442]]
means for effectively hedging against currency risk.\35\
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\34\ See Letter from Justin Hughes, CFA and Managing Member,
Philadelphia Financial Management of San Francisco to Elizabeth
Murphy, Secretary, Commission, dated August 2, 2011 (``Philadelphia
Financial Letter''). The commenter's suggestions for additional
regulation included limiting the product to only accredited
investors, establishing order handling rules as well as limiting
leverage and account churning.
\35\ See Philadelphia Financial Letter. See also Better Markets
Letter. See also supra section III.E. for a discussion of potential
alternatives to retail forex transactions, including currency
exchange traded products (``ETPs'').
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A third comment letter from a representative of another commenter
provided 2010 data from a small sampling of large broker-dealers with
an estimated notional value of foreign exchange conversion trades of
$13.55 billion and an estimated notional value of foreign exchange non-
conversion trades of $1.43 billion, although these values included
transactions with both ECPs and non-ECPs.\36\
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\36\ See letter from P. Georgia Bullitt, Michael A. Piracci and
F. Mindy Lo, Morgan Lewis to Joseph Furey, Bonnie L. Gauch and Adam
Yonce, Commission, dated July 28, 2011 (``Morgan Lewis Letter'').
This commenter provided data from five large-broker dealers, but,
only some of the broker-dealers provided information for every type
of transaction cited in the letter.
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Following the extension of the Interim Rule in July 2012, the
Commission received four additional comment letters from two
commenters.\37\ One commenter requested that broker-dealers be allowed
to continue to engage in, or enter into, a retail forex business. This
commenter argued that broker-dealers should be permitted to conduct
retail forex to offer their retail clients a full suite of investment
options and to facilitate hedging of transactions in foreign
stocks.\38\ This commenter also noted that broker-dealers have risk
management and customer suitability practices in place to monitor their
activities not only in stocks but also in options and stated that
retail forex activities should be able to be conducted within broker-
dealers and subject to regulatory oversight by the Commission. In a
separate communication, this commenter reiterated that the Commission
should allow active trading and hedging of spot forex under the same
guidelines as active trading of stocks and options.\39\ The commenter
asserted that brokers should be able to set their own margins, taking
into account the currency, the client, and the market conditions.\40\
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\37\ See email comments from Ernest J. Guevara III, dated
November 16, 2012 (this comment does not appear to be related to the
Interim Rule), and Brad Georges of Greeneye Management, dated
December 19, 2012 (``Greeneye Comment Email'') February 28, 2013
(``Second Greeneye Comment Email''), and April 17, 2013.
\38\ See Greeneye Comment Email.
\39\ See Second Greeneye Comment Email.
\40\ See id.
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As noted above, and as discussed in more detail below, the
Commission believes it is appropriate at this time to allow broker-
dealers to continue engaging in retail forex transactions subject to
existing restrictions under Commission and FINRA rules while any
additional requirements for retail forex are considered in order to
retain existing options for retail investors to access the foreign
exchange markets. This approach is consistent with the approach
contained in the Interim Rule and with the recommendations of most
commenters; however, the Commission is adopting Rule 15b12-1 with a
provision providing that the rule will expire on July 31, 2016. This
provides an additional opportunity for the Commission to assess the
market for retail forex and determine whether to issue more targeted
rules for retail forex, to consider any rules that an SRO may develop
regarding its members' retail forex activities, to consider whether to
take action to extend the rule, or have the rule expire.
To that end, Commission staff will consult with FINRA periodically
to discuss and obtain additional information about the retail forex
marketplace, such as information regarding new FINRA member
applications identifying retail forex business and any rules that FINRA
may consider regarding its members' retail forex activities. Commission
staff will also periodically consult with other regulatory agencies,
including the CFTC and banking regulators, to discuss the retail forex
marketplace and identify potential areas and instances of abuse, as
well as the ways that retail investors have benefited or been harmed.
In addition, the Commission will consider any relevant information
obtained during standard broker-dealer examinations.
II. Discussion
Taking into consideration all of the comments received, the
Commission believes it is appropriate at this time to allow broker-
dealers to continue to engage in retail forex transactions subject to
existing requirements under Commission and FINRA rules while any
additional requirements for retail forex are considered in order to
retain existing options for retail investors to access the foreign
exchange markets.
The Commission is adopting Rule 15b12-1 with the same terms and
conditions as the Interim Rule in order to permit broker-dealers to
continue to engage in a retail forex business under the framework of
the Exchange Act for the time period specified in the rule. The final
rule requires that broker-dealers comply with existing obligations
under the Exchange Act, the rules and regulations thereunder, and the
rules of the SRO of which the broker-dealer is a member.\41\ As
discussed in more detail below, the final rule meets the requirements
in Section 2(c)(2)(E)(iii) of the CEA that the rule treat all
agreements, contracts, and transactions in foreign currency described
in CEA section 2(c)(2)(B)(i)(I) and all agreements, contracts, and
transactions in foreign currency that are functionally or economically
similar to agreements, contracts, or transactions described in CEA
section 2(c)(2)(B)(i)(I), similarly, and that the rule prescribes
appropriate requirements with respect to disclosure, recordkeeping,
capital and margin, reporting, business conduct, and documentation by
requiring that broker-dealers engaged in a retail forex business comply
with the Exchange Act, the rules and regulations thereunder, and the
rules of the SRO of which the broker-dealer is a member.\42\
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\41\ Broker-dealers engaging in conversion trades are not
subject to the rule as a result of the CFTC's interpretation to
exclude conversion trades from retail forex, but they remain subject
to the Commission's antifraud authority, including Section 10(b) and
Rule 10b-5, under the Exchange Act when engaging in these trades.
\42\ 7 U.S.C. 2(c)(2)(E)(iii).
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The CFTC's interpretation regarding conversion trades that was
issued following the extension of the Interim Rule has significantly
narrowed the scope of retail forex transactions subject to a Commission
rule. While we have only limited information on the level of retail
forex activity conducted by broker-dealers, we received information
from one commenter asserting that, based on a sampling of a small
number of large broker-dealers, a substantial majority of foreign
exchange transactions engaged in by these broker-dealers are conversion
trades.\43\ Given the clarification regarding the exclusion of
conversion trades from the scope of retail forex transactions, we
believe that the scope of transactions that are currently considered to
be retail forex transactions, and thus subject to the Commission's
rule, is much more limited than what the Commission anticipated in the
Interim Rule.
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\43\ See Morgan Lewis letter.
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Conversion trades were the focus of many of the comments received
on the Interim Rule and the CFTC's interpretation was not issued until
after the Commission had extended the interim temporary final rule.
Given the recent modified scope of retail forex transactions to exclude
conversion trades and the limited comments received on issues related
to non-conversion trades, we believe it is appropriate to provide
additional time for the Commission to focus its review on the current
scope of activities that
[[Page 42443]]
are included in retail forex transactions prior to considering any
tailored rules for broker-dealers engaging in a retail forex business.
The CFTC has also adopted rules that contain requirements specific
to retail forex transactions including disclosure requirements, net
capital requirements and haircut deductions depending on the currency
pair, security deposit requirements and profitability reporting.\44\
Moreover, other regulatory agencies \45\ have also adopted rules that
are similar to the CFTC's rule, including the Board which very recently
adopted final rules related to retail forex transactions.\46\ These new
requirements may have an impact on the how the retail forex market
functions. The rule the Commission is adopting today differs from the
rules adopted by the CFTC and other regulatory agencies as it does not
contain the specific requirements tailored to the retail forex
transactions referenced above. While the Commission has determined to
adopt Rule 15b12-1 for the reasons discussed throughout this release
including the relatively limited level of retail forex activity engaged
in by broker-dealers and the existing framework of legal obligations,
including SRO rules applicable to broker-dealers, the Commission
anticipates the three-year sunset provision will provide it with
additional time to assess further the market for retail forex
(including any changes based on recent regulatory actions) and consider
whether to develop more targeted rules for retail forex, to consider
any rules that an SRO may develop regarding its members' retail forex
activities, to consider whether to take action to extend the rule, or
have the rule expire.
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\44\ See CFTC Final Rule.
\45\ See FDIC Final Rule, OCC Final Rule, and Board Final Rule.
\46\ See Board Final Rule.
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With respect to SRO rules, the Commission notes that FINRA has
previously proposed a rule to establish leverage limitations with
respect to retail forex \47\ and that the National Futures Association
(NFA) has in place rules governing retail forex activities.\48\ The
Commission understands that FINRA plans to continue to consider rules
related to retail forex transactions taking into account the regulatory
framework developed by other regulators. The Commission expects to
evaluate possible future actions during the sunset period in light of
developments in the retail forex market, as well as the Commission's
and SROs' experiences with retail forex activity pursuant to this rule.
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\47\ FINRA proposed a rule in 2009 to establish a leverage
limitation for retail forex. See Notice of Filing of Proposed Rule
Change as Modified by Amendment No. 2 to Adopt FINRA Rule 2380 to
Limit the Leverage Ratio Offered by Broker-Dealers for Certain Forex
Transactions, Exchange Act Release No. 61090 (Dec. 1, 2009), 74 FR
64776 (Dec. 8, 2009).
\48\ See e.g. NFA Compliance Rule 2-36. Requirements for Forex
Transactions, NFA Compliance Rule 2-39. Soliciting, Introducing, or
Managing Off-Exchange Retail Forex Transactions or Account, and NFA
Financial Requirement Section 11. Forex Dealer Member Financial
Requirements. The NFA rules that are relevant to retail forex
transactions can be found at http://www.nfa.futures.org/NFA-compliance/NFA-futures-commission-merchants/forex.HTML.
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The Commission has previously cautioned investors about risks in
the foreign exchange market generally, and highlighted certain key
risks for investors, including the lack of a central marketplace for
retail forex, uncertainty about transaction costs, and the possibility
for investors to lose more than their original investment.\49\
Commission staff also has cautioned investors that many forex traders
employ leverage as a means of amplifying their returns and higher
leverage, in the form of a small margin requirement, can result in
large losses if prices move in an unfavorable direction.\50\ The
Commission stated in the 2011 Interim Rule Release that insufficient
capital or margin requirements could result in costs to the market
associated with the inefficient provision of retail forex services.\51\
Although no instances of abuse with respect to retail forex involving
broker-dealers were raised in the comment letters,\52\ the Commission
remains concerned about risks in the retail forex market and the
potential harm to investors if abusive practices, including misleading
advertising or sales practices, are employed.\53\ We are, however,
mindful that retail forex transactions may be used for hedging and
gaining direct exposures to the foreign currency markets, which may be
appropriate for retail investors through broker-dealers with the
protections available to investors under existing Commission and SRO
oversight. We are also sensitive to the fact that the statutory
prohibition applies to BD-FCMs in the absence of Commission rules but
does not apply to FCMs that are not dually registered and are permitted
to engage in retail forex transactions pursuant to the CFTC's rules.
Accordingly, the failure to adopt a rule permitting BD-FCMs to continue
to conduct retail forex could affect investors who have an account at a
BD-FCM and would need to open a new account with a different
intermediary in order to continue to conduct retail forex transactions.
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\49\ See 2011 Interim Rule Release at 41677, noting media
reports of potentially abusive practices and concerns expressed by
other regulators with respect to the retail forex practices of the
entities they regulate. See also Forex Bulletin. Commission staff
also cautioned investors that there had been allegations of fraud by
the Commission and the CFTC in cases involving foreign exchange
investment schemes. Id.
\50\ See Forex Bulletin.
\51\ See 2011 Interim Rule Release at 41684.
\52\ The Better Markets Letter and Philadelphia Financial Letter
refer generally to widespread abuses in the retail forex market, but
do not cite specific instances of abuse involving intermediaries
that are broker-dealers. See Better Markets Letter and Philadelphia
Financial Letter.
\53\ The Commission encourages any person who is aware of
abusive practices or other misconduct in the retail forex market to
report those activities to the Commission.
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The sunset provision for the expiration of the rule is designed to
provide the Commission with a reasonable period of time to consider
further whether additional requirements for broker-dealers engaging in
a retail forex business may be appropriate while avoiding any
disruption or unintended consequences to broker-dealers and their
customers if the statutory prohibition were to go into effect. The
Commission believes that a three-year sunset, as opposed to a shorter
period, is appropriate because a shorter time frame may fail to provide
adequate time to reflect on any developments in the retail forex market
and then engage in any subsequent steps involved in any rulemaking
process, such as the proposal and adoption of new rules before the
expiration of Rule 15b12-1. Moreover, a longer time period may be
unnecessary because the Commission should have sufficient time to
consider and take any action prior to the expiration of the sunset
provision. As an alternative, the Commission could adopt a final rule
without a sunset provision or allow the temporary rule to lapse without
adopting any final rule.\54\ We believe, however, that in light of the
CFTC's interpretation regarding conversion trades in the context of the
retail forex market, as well as comments received both in support of
and against final Commission rules to permit broker-dealers to engage
in retail forex transactions, the arguments raised warrant further
consideration. Although
[[Page 42444]]
one commenter argued that Congress intended the ban on retail forex to
go into effect,\55\ we note that Congress specifically authorized the
Commission and other Federal regulatory agencies to permit their
regulated entities to engage in retail forex transactions by taking
regulatory action the agencies determined was appropriate.\56\
Furthermore, in addition to the Commission's Interim Rule, the CFTC and
bank regulatory agencies have all adopted final rules to permit their
regulated entities to engage in retail forex transactions.\57\ The
Commission will also consider any new information obtained with respect
to the retail forex market, including any evidence of abusive practices
or misconduct by BD-FCMs, prior to the expiration of the sunset period
to determine whether additional limitations or action may be warranted.
Any new requirements could be imposed either through Commission or SRO
rules.
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\54\ One commenter stated that exchange listed currency ETFs,
which as exchange-traded products are outside the scope of retail
forex, provide an alternative to retail forex for hedging purposes
and could give investors a greater return at a lower cost. See
Philadelphia Financial Letter. See also the discussion of ETFs in
the Economic Analysis section of this release. Other commenters,
however, argue that investors should be allowed to engage in retail
forex transactions with broker-dealers and that the current
regulatory framework offers sufficient protections. See Greeneye
Comment Email and SIFMA/ISDA Letter.
\55\ See Better Markets Letter. Another commenter argued that
retail forex transactions are essentially gambling and should be
regulated and taxed as such. See Philadelphia Financial Letter.
\56\ 7 U.S.C. 2(c)(2)(E)(ii)(I) and (iii)(I).
\57\ See supra note 14. See also supra note 45.
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The rule we are adopting today, Rule 15b12-1, has the same terms
and conditions as the Interim Rule that was adopted in 2011 and
extended in 2012, except with respect to the expiration date of the
rule as specified in paragraph (d) of the rule. Broker-dealers will
continue to be required to comply with existing Exchange Act and SRO
rules as they are applicable to retail forex transactions. We believe
that the same reasons behind the adoption of the Interim Rule in 2011
and its extension in 2012 and discussed throughout this release
continue to apply to the retail forex rule we are adopting today.\58\
---------------------------------------------------------------------------
\58\ See 2011 Interim Rule Release at 41678 for a discussion of
the rationale for adoption of the Interim Rule. See also 2012
Extension Release.
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A. Rule 15b12-1(a): Definitions
Rule 15b12-1(a) sets forth the definitions used in the rule,\59\
which have not changed since the Commission adopted the Interim Rule in
2011.\60\ Many of the definitions have the same meaning as in the
Exchange Act.\61\ These terms and definitions were selected because
their meanings are readily understood in the industry. Other terms,
such as ``retail forex business'' and ``retail forex transaction,'' are
substantially similar to terms in the OCC, FDIC, and Board final
rules.\62\
---------------------------------------------------------------------------
\59\ Rule 15b12-1(a).
\60\ See 2011 Interim Rule Release at 41678-79 for a discussion
of these definitions.
\61\ These include the definition of broker, dealer, person,
registered broker or dealer, and self-regulatory organization. See
2011 Interim Rule Release at 41677.
\62\ See 2011 Interim Rule Release at 41677-78 for a discussion
of these definitions.
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As we noted in the 2011 Interim Rule Release, the definition of
retail forex transaction is based on the CEA and incorporates the terms
described in CEA sections 2(c)(2)(B) and 2(c)(2)(C).\63\ In addition,
the definition is substantially the same as the definitions in the FDIC
Final Rule, the OCC Final Rule, and the Board Final Rule.\64\ Further,
we noted in the 2011 Interim Rule Release that the definition of retail
forex transaction has at least two important features. First, certain
transactions in foreign currency are excluded from the definition,
including spot transactions, contracts of sale that create an
enforceable obligation to deliver between a buyer and seller that have
the ability to deliver and accept delivery, respectively, in connection
with their line of business, and forex transactions executed or traded
on an exchange or designated contract market.\65\ As we discussed
previously, the exclusion for spot transactions was significantly
expanded after the CFTC issued an interpretation, following the
Commission's extension of the Interim Rule, that conversion trades are
considered to be spot transactions and are therefore outside the scope
of retail forex.\66\
---------------------------------------------------------------------------
\63\ 7 U.S.C. 2(c)(2)(B) and 7 U.S.C. 2(c)(2)(C).
\64\ See FDIC Final Rule at 40781, OCC Final Rule at 41376-
41377, and Board Final Rule at 21020-21021.
\65\ See 2011 Interim Rule Release at 41678-79.
\66\ See supra note 27.
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The second important feature of the definition is that a ``rolling
spot'' forex transaction (also known as a Zelener contract),\67\ is not
excluded from the definition as a spot transaction. Although a rolling
spot forex transaction normally requires delivery of currency within
two days, in practice these contracts are indefinitely renewed every
other day and no currency is actually delivered until one party
affirmatively closes out the position.\68\ The Commission believes that
a contract with a retail customer for a rolling spot forex transaction
is economically more similar to a retail forex future, as described in
CEA section 2(c)(2)(B)(i)(I), than a spot forex contract.\69\ This
interpretation is consistent with the approach of other Federal
regulatory agencies acting pursuant to section 742 of the Dodd-Frank
Act to treat all agreements, contracts, and transactions in foreign
currency described in CEA section 2(c)(2)(B)(i)(I) and all agreements,
contracts, and transactions in foreign currency that are functionally
or economically similar to agreements, contracts, or transactions
described in CEA section 2(c)(2)(B)(i)(I), similarly.\70\
---------------------------------------------------------------------------
\67\ See CFTC v. Zelener, 373 F.3d 861 (7th Cir. 2004); see also
CFTC v. Erskine, 512 F.3d 309 (6th Cir. 2008) (discussing Zelener
contracts).
\68\ See 2011 Interim Rule Release, note 34, at 41679. See also
CFTC Proposing Release at 3284-3285 for a discussion of Zelener
contracts and the CFTC's regulation of these contracts.
\69\ See 2011 Interim Rule Release at 41679.
\70\ See supra note 14.
---------------------------------------------------------------------------
The Commission received comments from two groups of commenters on
the definitions included in section (a) suggesting that the Commission
amend terms to clarify that conversion trades should not be
regulated.\71\ As discussed above, these comments both requested
changes that are no longer necessary in light of the CFTC's
interpretation regarding conversion trades.\72\
---------------------------------------------------------------------------
\71\ See SIFMA/ISDA Letter and ABA/GFMA Letter.
\72\ See supra note 31.
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B. Rule 15b12-1(b): Broker-Dealers Engaged in a Retail Forex Business
Rule 15b12-1(b) requires that a broker-dealer comply with the
Exchange Act, the rules and regulations thereunder, and the rules of
the SROs of which the broker-dealer is a member, insofar as they are
applicable to retail forex transactions.\73\ These include rules
related to the requirements of rules and regulations for retail forex
in Section 2(c)(E)(iii)(I) of the CEA,\74\ including but not limited to
rules for disclosure, recordkeeping (or documentation), capital and
margin, reporting, and business conduct.\75\ The Commission initially
adopted this section (b) in the same form in 2011 and the rationale for
our adoption of this section has not changed.
---------------------------------------------------------------------------
\73\ Rule 15b12-1(b).
\74\ 7 U.S.C. 2(c)(2)(iii)(I).
\75\ See 2011 Interim Rule Release at 41679-81 for a discussion
of some of the Exchange Act and SRO rules that are applicable to
broker-dealer retail forex transactions.
---------------------------------------------------------------------------
Provided below are examples of obligations also discussed in the
2011 Interim Rule Release, including certain SRO requirements, relating
to disclosure, recordkeeping (or documentation), capital and margin,
reporting, and business conduct that are applicable to broker-dealers'
retail forex transactions.
Disclosure Requirements
Broker-dealers that engage in a retail forex business must comply
with the disclosure requirements in NASD Rule 2210.\76\ NASD Rule 2210
requires all communications with the public by members of FINRA--
including forex-related communications--to be based on
[[Page 42445]]
principles of fair dealing and good faith, to be fair and balanced, and
to provide a sound basis for evaluating the facts regarding the market
generally and a customer's specific transaction.\77\ NASD Rule 2210
further prohibits broker-dealers from making ``any false, exaggerated,
unwarranted, or misleading statement or claim in any communication with
the public.''
---------------------------------------------------------------------------
\76\ See FINRA Forex Notice.
\77\ See id.
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Recordkeeping Requirements
Exchange Act Rules 17a-3 and 17a-4 require a broker-dealer to make,
keep current, and preserve records regarding its business. For example,
Exchange Act Rule 17a-3(a)(2) requires a broker-dealer to make and keep
current a general ledger, which provides details relating to all
assets, liabilities, income and expense and capital accounts, which
could include entries related to retail forex.
Net Capital and Margin Requirements
Each broker-dealer must comply with Exchange Act Rule 15c3-1, which
prescribes minimum regulatory net capital requirements for broker-
dealers. The Commission notes that, under Exchange Act Rule 15c3-
1(c)(2)(iv), any unsecured receivable arising from a retail forex
transaction must be deducted when computing the broker-dealer's net
capital.\78\ The provisions of the net capital rule dealing with
contractual commitment charges under Rule 15c3-1(c)(2)(viii) also apply
to commitments with respect to foreign currency. Generally, broker-
dealer margin requirements are set by Regulation T \79\ and SRO
rules.\80\
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\78\ 17 CFR 240.15c3-1(c)(2)(iv).
\79\ 12 CFR 220.
\80\ See supra note 47.
---------------------------------------------------------------------------
Reporting Requirements
A broker-dealer is required to file with the Commission periodic
financial and operational reports (e.g., annual audited financial
statements and periodic FOCUS Reports), as prescribed by Exchange Act
Rule 17a-5, that may include relevant information regarding a broker-
dealer's retail forex business, if any.\81\ In addition, FINRA has
advised its member firms that a broker-dealer's expansion of its
business to include retail forex transactions constitutes a material
change in business operations pursuant to NASD Rule 1017(a), and a
broker-dealer must first apply for and receive approval from FINRA to
conduct this activity.\82\ Additionally, Exchange Act Rule 17a-8
requires a broker-dealer to report to the U.S. Treasury Department's
Financial Crimes Enforcement Network certain enumerated types of
transactions, including suspicious transactions in foreign currencies
and foreign currency futures and options.\83\
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\81\ Retail forex data may factor into a broker-dealer's
financial reports; however, the presentation of such data on these
reports would be aggregated with other financial data associated
with the broker-dealer's activities and would not be specifically
identified as relating to retail forex. See, e.g., Form X-17A-5, 17
CFR 249.617. In addition, FINRA Rule 4524 requires broker-dealers to
file supplemental FOCUS information, including information about
commissions attributable to foreign exchange products in the
supplemental statement of income (``SSOI'') and information about
the gross amount of all foreign exchange forward transactions in the
supplemental schedule for derivatives and other off-balance sheet
items (``OBS''). See Exchange Act Release No. 66364 (February 9,
2012), 77 FR 8938 (February 15, 2012), and Exchange Act Release No.
68832 (February 5, 2013), 78 FR 9754 (February 11, 2013) (Commission
orders approving the SSOI and OBS, respectively).
\82\ See FINRA Forex Notice.
\83\ See Exchange Act Release No. 18321 (Dec. 10, 1981); 46 FR
61454 (Dec. 17, 1981); see also FINRA Rule 3310 (formerly NASD Rule
3011) (requiring FINRA member firms to establish and implement
policies and procedures that can be reasonably expected to detect
and cause the reporting of suspicious transactions). As FINRA noted,
``FINRA member firms engaging in retail forex activities should
ensure their Anti-Money Laundering Program addresses the risks
associated with the business and includes procedures for monitoring,
detecting, and reporting suspicious transactions associated with
their retail forex activities.'' See FINRA Forex Notice.
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Business Conduct Requirements
In the course of complying with certain Exchange Act requirements,
rules and regulations thereunder, and SRO rules relating to business
conduct, broker-dealers must address their retail forex business.\84\
For example, FINRA Rule 2010 (formerly NASD Rule 2110), which requires
broker-dealers, in the conduct of their business, to observe high
standards of commercial honor and just and equitable principles of
trade, applies to all of a broker-dealer's business, including its
retail forex business.\85\ FINRA has stated that to comply with FINRA
Rule 2010, a member firm must adequately disclose to its retail
customers that the firm is acting as a counterparty to a transaction,
the risks associated with forex trading, and the risks and terms of
leveraged trading.\86\ Broker-dealers also need to address retail forex
transactions in connection with the customer reserve bank account
requirements under Exchange Act Rule 15c3-3. In calculating what
amount, if any, a broker-dealer must deposit on behalf of its customers
in a reserve bank account pursuant to Exchange Act Rule 15c3-3(e), the
broker-dealer must use the formula set forth in Exchange Act Rule 15c3-
3a.
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\84\ The suitability requirement under FINRA Rule 2111 requires,
in part, that a broker-dealer or associated person ``have a
reasonable basis to believe that a recommended transaction or
investment strategy involving a security or securities is suitable
for the customer, based on the information obtained through the
reasonable diligence of the [firm] or associated person to ascertain
the customer's investment profile.'' This requirement would
generally not apply in the context of a retail forex transaction
unless it is part of a recommended investment strategy that also
involves a security.
\85\ See FINRA Forex Notice.
\86\ Id.
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As we noted in the Interim Rule Release, these examples are not
inclusive of all regulatory requirements administered by the Commission
that must be complied with by a broker-dealer engaging in a retail
forex business.\87\ The Commission does not intend to suggest that
other provisions, rules and regulations, including antifraud provisions
and SRO rules, may not apply to broker-dealers' retail forex business.
---------------------------------------------------------------------------
\87\ See 2011 Interim Rule Release at 41681.
---------------------------------------------------------------------------
While the Commission did not receive any comments that directly
addressed Rule 15b12-1(b), it received comments that set forth
recommendations for potential regulations that could apply to broker-
dealers' retail forex businesses.\88\ As discussed above, the
Commission believes it is appropriate to give additional consideration
to the recommendations provided by all of the commenters and is
adopting the rule to permit additional time for the Commission to
assess the market for retail forex and potentially develop more
targeted rules for retail forex and to consider any rules that an SRO
may propose regarding its members' retail forex activities.
---------------------------------------------------------------------------
\88\ See Philadelphia Financial Letter and Second Greeneye
Comment Email. See also supra note 34.
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C. Rule 15b12-1(c): Broker-Dealers Deemed To Be Acting Pursuant to a
Commission Rule
Rule 15b12-1(c) provides that any registered broker or dealer that
engages in a retail forex business in compliance with paragraph (b) of
the rule on or after the effective date of the rule will be deemed,
until the expiration date specified in paragraph (d) of the rule, to be
acting pursuant to a rule or regulation described in CEA section
2(c)(2)(E)(ii)(I), as amended by section 742 of the Dodd-Frank Act.\89\
The Commission adopted this section (c) in the same form in 2011 and
did not receive any comments that addressed this section.
---------------------------------------------------------------------------
\89\ Rule 15b12-1(c).
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[[Page 42446]]
D. Rule 15b12-1(d): Expiration
Rule 15b12-1(d) contains the expiration date of the rule.\90\ The
Commission is revising this paragraph of the rule to extend the
expiration date to July 31, 2016. As discussed above, this revision to
paragraph (d) will allow the rule to continue to apply while the
Commission considers whether any additional requirements are necessary
with respect to broker-dealer's retail forex activities. The Commission
will also consider other possible alternative actions, including
whether Rule 15b12-1 should be proposed, without a sunset provision, in
its current form. The Commission will also consider whether the rule
should be allowed to expire without further Commission action after the
effective period ends.
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\90\ Rule 15b12-1(d).
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III. Economic Analysis
A. Introduction
Section 3(f) of the Exchange Act requires the Commission to
consider or determine whether an action is necessary or appropriate in
the public interest, and to consider, in addition to the protection of
investors, whether the action would promote efficiency, competition,
and capital formation whenever it engages in rulemaking under the
Exchange Act.\91\ In addition, Section 23(a)(2) of the Exchange Act
requires the Commission, when making rules under the Exchange Act, to
consider the impact such rules would have on competition.\92\ Section
23(a)(2) of the Exchange Act prohibits the Commission from adopting any
rule that would impose a burden on competition not necessary or
appropriate to further the purposes of the Exchange Act.\93\
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\91\ See 15 U.S.C. 78c(f).
\92\ See 15 U.S.C. 78w(a)(2).
\93\ See id.
---------------------------------------------------------------------------
Many of the benefits and costs discussed below are difficult to
quantify. For example, we believe that a key benefit to the adoption of
Rule 15b12-1 is the prevention of inefficient disruptions in retail
customers' access to foreign exchange markets. However, in the absence
of current data on investor participation in the retail forex market,
the magnitude of these inefficiencies is difficult to estimate.
Specifically, if the alternative to conducting retail forex through a
broker is to open an account with an FCM, then an estimate of the
aggregate costs associated with the necessary account transfers would
likely require information about the number of customer accounts that
would be affected and the notional value of retail forex activity in
those accounts.
Similarly, as discussed below, we recognize that investors who
choose to use exchange-traded products to hedge currency risk will face
the risk that a hedging instrument does not perfectly replicate the
exposure to be hedged. While we might be able to estimate the quantity
of basis risk for a particular position, a measure of the economic
significance of this basis risk across the investor base to which a
prohibition on retail forex would apply requires information about the
foreign currency exposures that retail customers might seek to hedge.
Although one comment letter provided some data on the scope of the
market,\94\ the Commission does not have sufficient data about retail
forex participation to produce precise estimates of the aggregate
economic effects of adopting Rule 15b12-1 and possible alternatives to
this rulemaking. As a result, much of the discussion on costs and
benefits that follows is qualitative in nature. However, where
possible, the Commission has attempted to quantify some economic
effects.
---------------------------------------------------------------------------
\94\ See Morgan Lewis Letter which provides some estimate on the
overall scope of the retail forex market. See also supra section
I.E. for a discussion of this comment letter.
---------------------------------------------------------------------------
We understand that under the current regulatory regime, retail
customers typically enter into foreign exchange transactions with
broker-dealers for a number of reasons. Industry participants have
informed us that the most common foreign exchange transactions are
conversion trades, in which a currency trade is made in connection with
a foreign securities transaction. These are excluded from the scope of
retail forex transactions and thus from the Commission's rule as
discussed above.\95\ Based on data one commenter provided from a small
sampling of larger broker-dealers, in terms of notional amount, foreign
exchange conversion trades would account for approximately 90% of
foreign exchange transactions conducted through broker-dealers, and 99%
of all broker-dealer customer accounts are involved in conversion
trades, though not all trades within an account may be conversion
trades.\96\ Commenters have also conveyed to us that retail customers
often enter into forex transactions with broker-dealers as part of a
hedging strategy. For instance, retail customers may engage in forex
transactions through broker-dealers in order to hedge currency risk in
securities or in a portfolio held in the customer's brokerage account.
They may also engage in these transactions in order to obtain exposure
to foreign markets as part of their overall investment strategy.\97\
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\95\ See Morgan Lewis Letter. As explained above, the ABA/GFMA
Letter requested from the CFTC an interpretation that excluded
conversion trades from the prohibition under CEA section 2.
\96\ See Morgan Lewis Letter, which provided data from five
large-broker dealers, but, only some of the broker-dealers provided
information for every type of transaction that is cited in the
letter. The data included a sampling of five large broker-dealer
firms for forex data during the calendar year 2010 (or in one firm's
case, June 2010 through June 2011) showing that the estimated
aggregate notional value of conversion trades for the firms that
provided data for the year was $13.55 billion while the estimated
aggregate notional value of non-conversion trades was $1.43 billion.
The data also showed that the estimated annual number of accounts
involved in conversion trades for the time period was 17,600 and the
number of non-conversion accounts was 187. See id.
\97\ SIFMA/ISDA Letter at 4, Annex A at 1-2.
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Congress prohibited the retail forex transactions described in CEA
section 2(c) except pursuant to rules adopted by the relevant Federal
regulatory agencies allowing the transactions. As we noted in the 2011
Interim Rule Release, some of these transactions, such as hedging
transactions may be beneficial to investors as they provide a mechanism
for mitigating risks.\98\ At the same time, the Commission is aware of
potentially abusive practices that can occur in the retail forex
market. Such practices may include, for example, misleading or lack of
disclosure about fees and forex pricing, or misleading advertising
directed to retail investors.\99\
---------------------------------------------------------------------------
\98\ See 2011 Interim Rule Release at 41684.
\99\ See id.
---------------------------------------------------------------------------
As discussed above, on April 18, 2012, a group of commenters asked
the CFTC to take the view that forex transactions that are solely
incidental to, and are initiated for the sole purpose of, permitting a
client to complete a transaction in a foreign security, through
conversion trades would not be subject to the retail forex prohibition
under section 2 of the CEA.\100\ In August 2012, the CFTC issued an
interpretation in a joint rulemaking with the Commission that clarifies
that conversion trades are not retail forex transactions subject to the
prohibition under the CEA. This interpretation permits broker-dealers
to engage in conversion trades without a rulemaking by the Commission.
It also significantly reduces the level of broker-dealer foreign
exchange activity that is subject to the prohibition in section 2(c) of
the CEA and thus to the final rule.\101\
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\100\ See ABA/GFMA Letter.
\101\ This is in contrast to the estimated level of broker-
dealer foreign exchange activity that was understood to exist when
the Commission initially acted to adopt the Interim Rule in 2011 and
when it extended the Interim Rule in 2012.
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Although the CFTC interpretation excludes conversion trades from
the
[[Page 42447]]
definition of retail forex, hedging and speculative trading in foreign
currency (other than bona fide spot transactions) continue to fall
within the scope of the definition. Broker-dealers and BD-FCMs are
therefore prohibited from engaging in such retail forex activities
absent a Commission rule allowing them to do so.
Adopting Rule 15b12-1 will maintain the regulatory framework that
currently exists for broker-dealers under the Interim Rule, and will
not create new regulatory obligations. Furthermore, the rule will
preserve the ability of broker-dealers to provide, among other
services, hedging to retail customers while the Commission considers
what further steps to take, if any.
The Commission previously considered and discussed its economic
analysis of Rule 15b12-1T.\102\ When the Commission initially adopted
the Interim Rule in 2011, we solicited comment on the economic analysis
and received one comment that addressed the economic analysis.\103\ We
adopted Rule 15b12-1T on an interim final basis to allow the existing
regulatory framework for retail forex transactions to continue for a
defined period, to avoid potentially unintended consequences from
broker-dealers immediately discontinuing their retail forex business,
and to provide the Commission time to consider the appropriate
regulatory framework regarding retail forex transactions.\104\
Furthermore, parties who commented on the rule asked the Commission to
preserve the ability of investors to engage in retail forex
transactions through their broker-dealers.\105\ In July 2012, the
Commission extended the effective date of the Interim Rule to July 16,
2013 and received four comments (from two commenters) on the extension,
none of which addressed the economic analysis in the 2012 Extension
Release.\106\
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\102\ For a detailed description of the costs and benefits of
Rule 15b12-1T, see 2011 Interim Rule Release at 41684.
\103\ See Better Markets Letter.
\104\ See 2011 Interim Rule Release at 41683. As noted above, as
of the time the Commission adopted the Interim Rule and extended it,
the CFTC had not issued its interpretation that conversation trades
were not retail forex transactions.
\105\ Fourteen of sixteen commenters were in favor of the rule
and supported the ability of broker-dealers to conduct retail forex
transactions. See, e.g. SIFMA/ISDA Letter.
\106\ See supra note 37.
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B. Economic Baseline
The baseline for our economic analysis of the rule is the state of
the retail forex market in existence today after the adoption of the
Interim Rule and its extension, in which broker-dealers and BD-FCMs are
permitted to conduct retail forex transactions in compliance with the
existing federal securities laws and the rules of an SRO of which the
broker-dealer or BD-FCM is a member. As is indicated in the discussion
of economic effects and potential alternatives that follows, estimates
of the economic impacts of this rule crucially depend on current
participation in retail forex, both aggregate notional amounts and risk
exposures to different foreign currencies. Broker-dealers are not
required to report the foreign currency exposure of their retail
clients and commenters did not provide data on the foreign currency
exposure of their retail clients. Accordingly, the Commission only has
limited data on the level of participation in the retail forex market.
However, we have some information regarding the current size of the
retail forex market and the use of foreign exchange instruments by
retail investors from comment letters and other research.\107\ In
attempting to evaluate and confirm the estimates of the size of the
broker-dealer retail forex market, which as noted above included
conversion trades that now are excluded from the definition of retail
forex, the Commission also looked at information from the Bank of
International Settlements (BIS). This information indicates a recent
increase in retail participation in forex markets.\108\ Though BIS did
not separately compute statistics for the subset of activity defined as
retail forex by the CEA, nevertheless this may provide an indication of
a general trend spanning both retail forex and foreign exchange
transactions by retail customers that falls outside the definition of
retail forex.
---------------------------------------------------------------------------
\107\ See e.g. Morgan Lewis Letter and Philadelphia Financial
Letter.
\108\ See King, Michael and Dagfinn Rime. ``The $4 trillion
question: What explains FX growth since the 2007 survey?'' BIS
Quarterly Review, December, 2010 (attributing increased foreign
exchange turnover to retail investor participation, facilitated by
electronic execution platforms).
---------------------------------------------------------------------------
In addition, as mentioned above, one commenter provided data on
participation in forex markets taken from a small sampling of large
broker-dealers. According to this commenter, in terms of notional
amount, foreign exchange conversion trades account for approximately
90% of all foreign exchange transactions (including transactions with
both ECPs and non-ECPs) conducted by these broker-dealers.\109\ This
supports the premise that a large portion of foreign exchange activity
flowing through broker-dealers falls outside of the scope of retail
forex. Further, 99% of all broker-dealer customer accounts in this
sample were involved in conversion trades. However, not all foreign
exchange transactions engaged in by retail customers were conversion
trades. The same commenter estimated transactions with a notional value
of $550 million per month in currency forwards, options and rolling
spot with non-ECPs.\110\ Accordingly, while conversion trades might
comprise the bulk of foreign exchange transactions engaged in by retail
investors, their participation in other forms of foreign exchange
transactions that fall within the scope of retail forex may be
significant.
---------------------------------------------------------------------------
\109\ See SIFMA Letter.
\110\ See id.
---------------------------------------------------------------------------
C. Benefits
Rule 15b12-1 is designed to preserve retail customers' access to
the forex markets through broker-dealers and thus promote efficiency
by, for example, permitting retail customers to continue to enter into
forex transactions in connection with trades in foreign securities, as
part of their brokerage activities until such time as Rule 15b12-1
expires by its terms or the Commission takes further regulatory action
in this area. In the absence of Rule 15b12-1, broker-dealers would be
required to exit certain types of retail forex business, which could
require retail customers to engage in forex transactions through an FCM
that is not dually registered as a broker-dealer or other service
provider which could be economically inefficient.\111\ In particular,
to the extent that access to the forex markets through broker-dealers
provides hedging opportunities for foreign investments, economic
benefits may accrue to retail customers. Furthermore, by continuing to
preserve a channel for broker-dealers' retail customers to access forex
transactions through broker-dealers, the adoption of the final rule
will continue to prevent any loss of competition in the retail forex
market that could result if broker-dealers or BD-FCMs were required to
exit the business. Adopting the rule also avoids potentially unintended
consequences from broker-dealers immediately discontinuing their retail
forex business, including costs or
[[Page 42448]]
inefficiencies that may result if retail customers have to open new
accounts with FCMs that are not BD-FCMs or with other entities in order
to trade in retail forex or seek to trade in products that may perform
as substitutes to retail forex, such as currency ETPs.
---------------------------------------------------------------------------
\111\ Establishing an account with an FCM may not bear a
monetary cost, however, a deposit of several thousand dollars is
frequently required to maintain an open account. A customer could
experience increased costs from maintaining separate deposit
minimums for securities and commodities accounts. In addition, other
costs may also apply, such as resources associated with transferring
accounts.
---------------------------------------------------------------------------
The adoption of the rule would not necessarily promote competition
between broker-dealers and the other regulated intermediaries because
broker-dealers would continue to offer retail forex services under Rule
15b12-1 which imposes requirements that already apply to broker-dealers
under the existing regulatory regime, while other regulated entities
were required to comply with new rules applicable to them. Further, all
broker-dealers engaging in a retail forex business must comply with the
final rule; therefore, competition among broker-dealers would most
likely not be affected by adoption of the rule.
Adopting Rule 15b12-1 will impose no new burden on competition and
should maintain competition among intermediaries. Under Rule 15b12-1T,
regulatory requirements for broker-dealers operating in the retail
forex market would remain unchanged. As a result, retail customers
would continue to be able to choose between hedging their own
portfolios of foreign securities in a securities account or relying on
other intermediaries or products for hedging. Similarly, since the rule
preserves the existing regulatory structure, the Commission does not
expect that adopting the rule will result in any impact on efficiency
or impairment of the capital formation process.
D. Costs
Because Rule 15b12-1 preserves the regulatory regime that had been
in place prior to the effective date of Section 742(c) of the Dodd-
Frank Act, the adoption of the rule imposes no new regulatory burdens
beyond those that already existed for broker-dealers. The Commission
recognizes that broker-dealers will face regulatory costs and
requirements associated with operating in the retail forex market, but
these are not new costs or requirements imposed by the rule.\112\ As
discussed above, the Commission is aware of potentially abusive
practices that may occur in the retail forex market.\113\ To the extent
that such practices occur after adoption of this rule retail customers
may bear the costs associated with these abuses.\114\ The Commission
notes that due to the CFTC's interpretation of the definition of retail
forex,\115\ the scope of retail forex transactions has narrowed
significantly after the Commission adopted and extended the Interim
Rule. As noted above, while the Commission only has limited information
about the size of the retail forex market, we believe the scope of the
retail forex market is much smaller than anticipated when the
Commission adopted and extended the Interim Rule and that the number of
transactions currently engaged in by broker-dealers, and therefore
covered by a Commission retail forex rule, is much more limited.\116\
The Commission believes, on balance, that the potential market
disruption that may occur if the Commission does not adopt Rule 15b12-1
justifies the cost of maintaining the current regulatory regime while
the Commission considers, during the time period set in the rule,
whether further regulatory action is warranted.
---------------------------------------------------------------------------
\112\ These costs include costs related to disclosure,
recordkeeping and documentation, capital and margin, reporting, and
business conduct. A broker-dealer that currently engages in forex
transactions with retail customers, for example, incurs costs
associated with establishing, maintaining, and implementing policies
and procedures to comply with regulatory requirements; preparing
disclosure documents; establishing and maintaining forex-related
business records; and preparing filings with the Commission, which
may include legal and accounting fees. See, e.g., 2011 Interim Rule
Release at 41684.
\113\ See 2011 Interim Rule Release at 41684.
\114\ See Forex Bulletin.
\115\ See supra note 26 and note 27.
\116\ See, e.g., Morgan Lewis Letter and SIFMA Letter. As noted
by commenters and discussed above, most forex activity engaged in by
retail customers is conversion trades and would no longer be subject
to a Commission rule on retail forex.
---------------------------------------------------------------------------
E. Alternatives Considered
The Commission considered certain alternatives to adopting Rule
15b12-1. One alternative would be to allow Rule 15b12-1T to expire
without adopting a final rule, and therefore preclude broker-dealers
from engaging in a retail forex business, although they could continue
to enter into conversion trades. A benefit of this alternative could be
that certain abuses Congress sought to address through the prohibition
in Section 742 of the Dodd-Frank Act could be addressed through a
complete prohibition. The cost of this alternative would be that an
outright prohibition on retail forex activity would interfere with
certain business activities conducted by broker-dealers that are
potentially beneficial for their customers, including hedging
activities.\117\
---------------------------------------------------------------------------
\117\ See 2011 Interim Rule Release at 41684.
---------------------------------------------------------------------------
A retail investor seeking to hedge currency risks in a portfolio
would have to choose between alternative means of doing so. Trading in
currency futures is one such alternative, but under this approach,
retail customers of broker-dealers would be required to open an account
with a FCM that is not dually registered as a broker-dealer. Moreover,
mark-to-market margin requirements associated with futures contracts
would expose hedging customers to additional cash flow risk. While
shifting to services provided by a different intermediary would impose
additional costs, retail customers could, however, potentially benefit
from the protection of rules to which those intermediaries are subject.
In comment letters responding to the solicitation of comment in the
2011 Interim Rule Release, one commenter suggested another way for
retail investors to obtain currency exposure is through ETPs.\118\
Another commenter suggested that the Commission had not thoroughly
analyzed the extent to which other products or trading strategies
represent substitutes for retail forex.\119\
---------------------------------------------------------------------------
\118\ See Philadelphia Financial Letter. See also Better Markets
Letter. As described above, the commenters referred to using
currency ETFs. In the discussion here, the term ETPs is used to
encompass a broader range of potential instruments (including ETFs)
that may be used to gain exposure to forex.
\119\ See Better Markets Letter.
---------------------------------------------------------------------------
In response to the commenters' concerns, we noted in the 2012
Extension Release that currency ETPs are generally designed to provide
broad exposure to exchange rate movements.\120\ In this regard, the
Commission notes that factors such as accrued interest or sponsor fees
may cause an ETP to deviate from its benchmark. We also note that a
market participant who uses ETPs as a hedging tool could face risks
from executing hedges on an exchange that may be markedly different
from the execution risk associated with transacting through a broker-
dealer.\121\ As such, and consistent with statements in the 2012
Extension Release, it does not appear that currency exchange-traded
funds will necessarily function as effectively in mitigating the
currency risk of particular securities transactions as retail
forex.\122\
---------------------------------------------------------------------------
\120\ See 2012 Extension Release at 41675.
\121\ See, e.g., Kostovetsky, Leonard. ``Index mutual funds and
exchange-traded funds.'' The Journal of Portfolio Management 29.4
(2003), while comparing ETFs to index funds, the author describes
the different sources of tracking error incurred by ETF investors,
including management fees and transaction costs in the form of bid-
ask spreads.
\122\ Id.
---------------------------------------------------------------------------
In the 2012 Extension Release, the Commission solicited specific
comment on currency ETFs, including on the concerns raised in the
comment letters received in response to the 2011 Interim Rule
Release,\123\ the benefits and costs
[[Page 42449]]
to retail customers of using currency ETFs as a substitute for retail
forex, and on the use of currency ETFs to hedge currency risk.\124\ The
Commission did not receive any comments in response to this
solicitation of comment regarding currency ETFs, and the Commission
continues to believe that ETPs represent an imperfect substitute for
retail forex. In evaluating further the concerns expressed, however,
Commission staff supplemented the analysis regarding the additional
risks that investors who use ETPs as hedging instruments may have to
bear discussed in the 2012 Extension Release and above.
---------------------------------------------------------------------------
\123\ See supra note 118.
\124\ See 2012 Extension Release at 41674.
---------------------------------------------------------------------------
Specifically, staff attempted to estimate the basis risk borne by
an investor using an ETP to hedge EURUSD exposure.\125\ While, on an
annual basis, the average difference between ETP returns and EURUSD
spot returns is small, the volatility of these differences from day-to-
day is high, approximately 0.50% at a daily frequency. This volatility
is indicative of the additional risk associated with hedging using
ETPs, particularly for short holding periods or frequent rebalancing.
Under Rule 15b12-1, the same investor could consider using a forward
contract for EURUSD in her brokerage account. While the average
difference in daily returns is higher in this case than with an ETP,
due to the interest rate differential between Europe and the United
States, the volatility of these differences is much lower, less than
one basis point at a daily frequency.\126\
---------------------------------------------------------------------------
\125\ Commission staff chose EURUSD for its analysis due to
ready availability of data on ETPs, equity indices and foreign
exchange rates related to the Euro area, and because an ETP tracking
EURUSD was more liquid than ETPs tracking other currencies during
the sample period. As a result of the additional liquidity,
Commission staff expects this ETP to result in less exposure to
basis risk with respect to EURUSD than other ETPs in the same family
constructed to track other currency pairs.
\126\ Calculated based on data from Daily/Monthly U.S. Stock
Files (copyright) 2012 Center for Research in Security Prices
(CRSP), The University of Chicago Booth School of Business, and
Thomson Reuters Datastream. To compute these statistics, Commission
staff used daily WM Spot closing prices, short-term interest rates
and prices for the CurrencyShares Euro ETN (ARCA: FXE) from 9/4/
2007-12/31/2012 obtained from Datastream (interest rates and
exchange rates) and CRSP (ETN returns). With these data, staff
computed daily returns to (i) a EURUSD forward contract; and (ii) to
the CurrencyShares Euro ETN. To compute the additional risk faced by
a EURUSD hedger using each of these instruments, staff produced time
series of the differences in daily returns and computed the average
and standard deviations of these series.
---------------------------------------------------------------------------
Finally, we note that if market participants prefer to transact in
ETPs in order to obtain currency exposure, they may do so regardless of
whether the Commission has or has not adopted rules for retail forex.
In this regard, while the Commission continues to believe that ETPs
have their own attendant risks, during the time Rule 15b12-1 is in
place until its expiration date, the Commission will continue to
evaluate the retail forex market, including alternative means of
hedging currency risk and the availability of substitutes to retail
forex. As such, as discussed throughout the release, the Commission
believes that it is appropriate to allow broker dealers to continue
engaging in retail forex transaction subject to existing requirements
during that time.
If, as an alternative to the final rule, the Commission allowed the
Interim Rule to expire, investors with international portfolios who are
restricted from retail forex may choose to leave currency exposures
unhedged. The risk of a portfolio of foreign securities that is not
hedged, with returns computed in U.S. dollar terms, comprises (i) The
risk of the underlying securities in local currency; (ii) the risk of
the local currency relative to the U.S. dollar; and (iii) the
correlation between the underlying security returns in local currency
and currency returns. Allowing investors to hedge currency exposures
removes components (ii) and (iii), leaving investors to bear only the
risk associated with the underlying securities.\127\
---------------------------------------------------------------------------
\127\ Based on data from Thomson Reuters Datastream, Commission
staff used monthly returns for the period 9/4/2007-12/31/2012 to
estimate the annualized risk and return for (i) the MSCI Europe
index, unhedged in USD and (ii) the MSCI Europe index, hedged to
USD. Staff chose these indices to simplify the computation of
portfolio returns for various hedge ratios. Based solely on point
estimates, partially-hedged portfolios offered higher total return
per unit of risk.
---------------------------------------------------------------------------
Further, inefficiencies stemming from an inability to pursue
currency hedging strategies in international portfolios, or higher
costs of doing so, could cause investors to reduce their allocation to
international investments. In the limit, investors may respond by
exiting international markets. The resulting lack of diversification
could represent a reduction in portfolio efficiency.\128\
---------------------------------------------------------------------------
\128\ See, e.g., French, Kenneth R. and James M. Poterba.
``Investor Diversification and International Equity Markets,''
American Economic Review, Vol. 81, No. 2, 1991, noting that large
variation in expected returns across countries is required to
justify lack of diversification in a mean-variance optimization
setting.
---------------------------------------------------------------------------
The Commission also considered adopting Rule 15b12-1 without a
sunset provision. While the direct costs and benefits of this
alternative would be similar to those applicable under the rule being
adopted (as it would simply continue the existing regulatory
requirements for broker-dealers engaging in retail forex transactions),
it nevertheless could limit the Commission's ability to fully consider,
prior to issuing permanent rules, potential changes to the retail forex
market; in part changes resulting from actions by other regulators that
have recently adopted rules relating to retail forex that impose
different requirements on market intermediaries than those the
Commission imposes on broker-dealers under Rule 15b12-1. The Commission
anticipates that it will reconsider the rule prior to its expiration in
light of developments in the retail forex market during that time, as
well as the Commission's and SROs' experiences with retail forex
trading pursuant to this Rule.
F. Conclusion
The adoption of Rule 15b12-1 will not change the regulatory
requirements for broker-dealers operating in the retail forex market.
Similarly, the rule does not alter the existing regulatory structure.
To the extent that potentially abusive practices continue in the retail
forex market, the market will continue to bear the costs associated
with any such abuses and the resultant inefficient provision of
services across the market. The rule will continue to allow retail
customers access to hedging transactions and other forex transactions
through broker-dealers, without the need to shift business and open new
accounts at other market intermediaries. If the Commission or an SRO
imposes any additional burdens on retail forex transactions the new
burdens will be considered in conjunction with those new rules.
IV. Other Matters
The Administrative Procedure Act generally requires that an agency
publish a substantive rule in the Federal Register 30 days before it
becomes effective.\129\ This requirement, however, does not apply if
the agency finds good cause for making the rule effective sooner.\130\
The Commission notes that Rule 15b12-1 does not impose any new
regulatory requirements on broker-dealers and that the rule is
identical in substance to the Interim Rule, which requires that broker-
dealers comply with existing Commission and SRO rules as they are
applicable to retail forex transactions. A 30-day effective date is
therefore not necessary for broker-dealers to prepare to comply with
the rule. Furthermore, broker-dealers are currently permitted to engage
in a retail forex business under
[[Page 42450]]
the Interim Rule. A gap in the effective dates of the Interim Rule and
the final rule would cause the statutory prohibition to go into effect
for a short period of time and could potentially create disruption and
unintended consequences to broker-dealers and their customers.\131\ For
these reasons,\132\ the Commission finds that there is good cause for
making the rule effective earlier than 30 days after publication in the
Federal Register.
---------------------------------------------------------------------------
\129\ See 5 U.S.C. 553(d).
\130\ Id. at 553(d)(3).
\131\ See, generally, the discussion in section III.C. regarding
the effect on retail customers if broker-dealers are not permitted
to engage in retail forex transactions.
\132\ The Commission also notes that, as discussed above, there
have been some recent developments related to retail forex
transactions, including the adoption in April 2013 of final rules by
the Federal Reserve. See Board Final Rule (effective May 13, 2013).
---------------------------------------------------------------------------
V. Paperwork Reduction Act
The Commission notes that Rule 15b12-1 does not impose any new
``collection of information'' requirements within the meaning of the
Paperwork Reduction Act of 1995 (``PRA''),\133\ nor does it create any
new filing, reporting, recordkeeping, or disclosure reporting
requirements for broker-dealers that are or plan to be engaged in a
retail forex business. Accordingly, the Commission did not submit the
rule to the Office of Management and Budget for review in accordance
with the PRA.
---------------------------------------------------------------------------
\133\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
In the 2011 Interim Rule Release and the 2012 Extension Release,
the Commission requested comment on its conclusion that there are no
collections of information in connection with the Interim Rule.\134\
The Commission received no comments relating to the PRA analysis in the
2011 Interim Rule Release or the 2012 Extension Release.
---------------------------------------------------------------------------
\134\ See 2011 Interim Rule Release at 41683-84.
---------------------------------------------------------------------------
VI. Regulatory Flexibility Act Certification
In the 2011 Interim Rule Release, the Commission certified that
pursuant to 5 U.S.C. 605(b) the Interim Rule, which is substantively
the same as Rule 15b12-1 (with the exception of the sunset date), will
not have a significant economic impact on a substantial number of small
entities. The Commission received no comments on the certification
included in the 2011 Interim Rule Release. The Commission also made
this certification in the 2012 Extension Release and the Commission
received no comments on that certification. Like the Interim Rule, Rule
15b12-1 applies to broker-dealers that may engage in retail forex
transactions. However, the rule does not impose new regulatory
obligations, costs, or burdens on such broker-dealers. While the rule
applies to broker-dealers that may be small businesses, any costs or
regulatory burdens incurred as a result of the rule are the same as
those incurred by small broker-dealers prior to the effective date of
section 742 of the Dodd-Frank Act. Broker-dealers have already incurred
those costs and regulatory burdens through establishing compliance with
the rules adopted by the Commission under the Exchange Act applicable
to broker-dealers, as well as relevant SRO rules. Further, the rule
does not change the burdens on small broker-dealers relative to large
broker-dealers. Accordingly, the rule will not have a significant
economic impact on a substantial number of small entities.
VII. Statutory Authority and Text of Rule and Amendment
Pursuant to section 2(c)(2) of the Commodity Exchange Act, as well
as the Exchange Act as amended, the Commission is adopting Exchange Act
Rule 15b12-1.
List of Subjects in 17 CFR Part 240
Brokers, Consumer protection, Currency, Reporting and recordkeeping
requirements.
In accordance with the foregoing, the Securities and Exchange
Commission is amending Title 17, chapter II, of the Code of Federal
Regulations as follows:
Text of the Rule and Amendment
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
1. The general authority citation for Part 240 is revised to read as
follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78c-3, 78c-5, 78d, 78e, 78f,
78g, 78i, 78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78n-1, 78o, 78o-4,
78o-10, 78p, 78q, 78q-1, 78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20,
80a-23, 80a-29, 80a-37, 80b-3, 80b-4, 80b-11, 7201 et. seq., and
8302; 7 U.S.C. 2(c)(2)(E); 12 U.S.C. 5221(e)(3); 18 U.S.C. 1350; and
Pub. L. 111-203, 939A, 124 Stat. 1376, (2010), unless otherwise
noted.
* * * * *
0
2. Add Sec. 240.15b12-1 to read as follows:
Sec. 240.15b12-1 Brokers or dealers engaged in a retail forex
business.
(a) Definitions. In addition to the definitions in this section,
the following terms have the same meaning as in the Securities Exchange
Act of 1934 (15 U.S.C. 78a et seq.): ``broker,'' ``dealer,''
``person,'' ``registered broker or dealer,'' and ``self-regulatory
organization.''
(1) Act means the Securities Exchange Act of 1934 (15 U.S.C. 78a et
seq.).
(2) Retail forex business means engaging in one or more retail
forex transactions with the intent to derive income from those
transactions, either directly or indirectly.
(3) Retail forex transaction means any account, agreement, contract
or transaction in foreign currency that is offered or entered into by a
broker or dealer with a person that is not an eligible contract
participant as defined in section 1a(18) of the Commodity Exchange Act
(7 U.S.C. 1a(18)) and that is:
(i) A contract of sale of a commodity for future delivery or an
option on such a contract;
(ii) An option, other than an option executed or traded on a
national securities exchange registered pursuant to section 6(a) of the
Act (15 U.S.C. 78(f)(a)); or
(iii) Offered, or entered into, on a leveraged or margined basis,
or financed by a broker or dealer or any person acting in concert with
the broker or dealer on a similar basis, other than:
(A) A security that is not a security futures product as defined in
section 1a(47) of the Commodity Exchange Act (7 U.S.C. 1a(47)); or
(B) A contract of sale that:
(1) Results in actual delivery within two days; or
(2) Creates an enforceable obligation to deliver between a seller
and buyer that have the ability to deliver and accept delivery,
respectively, in connection with their line of business.
(b) Any registered broker or dealer may engage in a retail forex
business provided that such broker or dealer complies with the Act, the
rules and regulations thereunder, and the rules of the self-regulatory
organization(s) of which the broker or dealer is a member, including,
but not limited to, the disclosure, recordkeeping, capital and margin,
reporting, business conduct, and documentation requirements, insofar as
they are applicable to retail forex transactions.
(c) Any registered broker or dealer that is engaged in a retail
forex business in compliance with paragraph (b) of this section on or
after the effective date of this section shall be deemed to be acting
pursuant to a rule or regulation described in section 2(c)(2)(E)(ii)(I)
of the Commodity Exchange Act (7 U.S.C. 2(c)(2)(E)(ii)(I)).
(d) This section shall expire and no longer be effective on July
31, 2016.
Dated July 11, 2013.
[[Page 42451]]
By the Commission.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2013-17015 Filed 7-15-13; 8:45 am]
BILLING CODE 8011-01-P