Off-Exchange Foreign Currency Trading

Trading in foreign currency futures and options contracts by retail customers outside of an organized exchange is unlawful unless the party offering the futures and options contracts is a regulated entity described in the Commodity Exchange Act enforced by the Commodity Futures Trading Commission.

Trading by retail customers in foreign currency exchange rates may take place:

• On an exchange regulated by the Commodity Futures Trading Commission such as the Chicago Mercantile Exchange, which provides a venue for the trading of contracts with a set size and a fixed expiration date;
• On exchanges regulated by the Securities and Exchange Commission such as the Philadelphia Stock Exchange, which offers options on foreign currencies; or
• On the over-the-counter market, also known as the off-exchange market, in which a “retail customer” such as a business or an individual trades directly with a counterparty.

The Commodity Futures Modernization Act of 2000 was enacted in December 2000 to provide for jurisdiction of the Commodity Futures Trading Commission over foreign currency futures and options trading. The Act provides that an off-exchange offer of foreign currency futures or options contracts to retail customers is unlawful unless the offering counterparty is a registered “futures commission merchant” or an affiliated person of a registered futures commission merchant.

Persons employed by a futures commission merchant must register with the Commodity Futures Trading Commission as an associated person of the futures commission merchant. Other entities that introduce retail customers to futures commission merchants must register as introducing brokers. Entities that may be considered futures commission merchants include financial institutions, registered broker-dealers, associated persons of registered broker-dealers, insurance companies or regulated affiliates of insurance companies, financial holding companies, and investment bank holding companies.

The Commodity Futures Trading Commission has authority under the Commodity Exchange Act to take action to halt foreign exchange trading operations of entities that do not qualify as a futures commission merchants. The Commission also may take action against regulated futures commission merchants that violate provisions of the Commodity Exchange Act prohibiting fraud and manipulation.

Retail trading in foreign exchange futures and options also is regulated in part by the National Futures Association. The National Futures Association is a self-regulatory organization recognized by the United States government. The Association requires that registered futures commission merchants must take responsibility for unregulated entities that obtain retail customers for the merchants. Also, standards are set by the Association for futures commission merchants to follow, including standards of conduct and employee supervision, standards regarding minimum net capital requirements, and standards for customer security deposits.

Copyright 2012 LexisNexis, a division of Reed Elsevier Inc.