SEC Adopts Retail Foreign Exchange Rule in Order to Prevent Dodd-Frank Amendment from Disrupting the Retail Forex Markets

by Dechert LLP
Contact

The U.S. Securities and Exchange Commission (“SEC”) on July 11, 2013 adopted Rule 15b12-1 (“Final Rule”) under the Securities Exchange Act of 1934 as amended (“Exchange Act”) in order to allow market participants to continue to benefit from accessing the retail foreign exchange (“forex”) markets.1 In the absence of the Final Rule, an amendment to the Commodity Exchange Act as amended (“CEA”) effected by Section 742 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) would have prevented broker-dealers from entering into or executing retail forex transactions with any person except an eligible contract participant” (“ECP”).2

Dodd-Frank Section 742

Only retail forex dealers, banks, insurance companies, futures commission merchants (“FCMs”) and broker-dealers registered with the SEC may act as market makers in forex transactions. The majority of forex transactions that these parties enter into are with ECPs, such as corporations and banks that are seeking to hedge the risk involved with fluctuations in foreign currencies in which their assets may be denominated. However, as the SEC explained in the Adopting Release, “[i]n recent years, a secondary off-exchange market for forex has developed for retail customers.”3

Due to perceived risks to retail investors in this market, the Dodd-Frank Act amended the CEA to make it unlawful for any broker-dealer4 to enter into a retail forex transaction, unless the counterparty is an ECP, except pursuant to a rule promulgated by the SEC. To implement this provision, the SEC initially adopted interim final temporary Rule 15b12-1T in order to allow broker-dealers to continue to operate in the retail forex markets without any disruption.5 The interim final rule was set to expire on July 16, 2013; the Final Rule allows broker-dealers to operate pursuant to a rule promulgated by the SEC until the Final Rule’s sunset provision takes effect on July 16, 2016.

SEC Concerns with Market Disruption

Citing the potential inability of broker-dealers to settle foreign currency denominated securities transactions for retail customers, the SEC was concerned that, without initial final temporary Rule 15b12-1T or the Final Rule, Dodd-Frank Section 742 “may have serious adverse consequences for certain markets in the absence of rulemaking by the [SEC].”6 Another concern expressed by the SEC with allowing the interim final temporary rule to expire was that FCM/broker-dealers dually registered with the CFTC and the SEC would have to close their retail forex accounts while FCMs registered only with the CFTC would be allowed to continue to operate pursuant to CFTC rules. The consequence of this scenario would have been that customers of the FCM/broker-dealers would have had to close their accounts and open new accounts with FCMs in order to access the retail forex markets.

In light of these concerns, the Final Rule allows the retail forex markets to continue to function in their current state so that the SEC can “assess the market . . . and potentially develop more targeted rules for retail forex or to consider any rules that [a self-regulatory organization ("SRO")] may propose regarding its members’ retail forex activities.”Additionally, the SEC stated that it believes that not allowing the Dodd-Frank amendment to interfere with the retail forex markets “is appropriate at this time to allow broker-dealers to continue engaging in retail forex transactions subject to existing restrictions under [SEC] 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.”8

The SEC also acknowledged its concerns regarding the retail forex markets, particularly the potential for abusive practices such as misleading advertising or sales practices. At the same time, the SEC also weighed the concerns mentioned above, including disrupting legitimate activity in the retail forex markets. Having considered these competing factors, the SEC included a sunset provision providing for a termination date of the Final Rule on July 16, 2016, so that the SEC had “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.”9

Final Rule 15b12-1

The Final Rule is simple in its application – any broker-dealer may engage in retail forex transactions as long as the broker-dealer complies with the Exchange Act and the rules thereunder, and complies with the relevant rules of any SRO of which the broker-dealer is a member. Further, the Final Rule states that any registered broker-dealer that complies with such SRO rules will be “deemed to be acting pursuant to a rule or regulation” as required by the Dodd-Frank amendment to the CEA.

A key issue considered by the SEC was the definition of a retail forex transaction. The Adopting Release lists certain types of transactions excluded from the definition, such as:

  • spot forex transactions, which occur when one currency is exchanged for another and the exchange happens within two days – spot forex transactions include conversion trades, which occur when a foreign exchange transaction “facilitates the settlement of a foreign security transaction;”10
  • forward contracts, subject to certain conditions; and
  • options executed on an exchange registered under Section 6(a) of the Exchange Act.

Importantly, the definition of a retail forex transaction includes a transaction with a person other than an ECP in a foreign currency and that is:

  • a contract of sale of a commodity for future delivery (or an option on such a contract);
  • an option (other than an option executed or traded on a national securities exchange registered pursuant to Section 6(a) of the Exchange Act); or
  • offered by a broker or dealer on a leveraged or margined basis, or otherwise financed by a broker or dealer.11

This definition includes speculative trading and hedging in a foreign currency. Also included are rolling spot transactions, which are contracts that normally require delivery within two days but the counterparties indefinitely renew the contract every other day so that no currency is ever delivered until one party closes out the position well past the initial two-day agreement.12 Additionally, in order for a broker-dealer’s retail forex activities to come into compliance with Rule 15b12-1, the broker-dealer must comply with certain other requirements, including disclosure, recordkeeping, net capital, margin, reporting and business conduct requirements.

Conclusion

The SEC has taken the appropriate step of allowing the retail forex markets to operate under the status quo for three more years while it conducts further studies in order to make informed changes to the retail forex markets. The SEC’s adoption of the Final Rule in this form has shown the SEC’s willingness to heed the Congressional mandate imposed on it by Dodd-Frank Section 742 while, at the same time, attempting to avoid additional market disruption.

Footnotes

1. Retail Foreign Exchange Transactions, 78 FR 42439 (Jul. 16, 2013) (“Adopting Release”).

2. An ECP, among others, as relevant to this rule, is an individual who has aggregate amounts invested on a discretionary basis of more than $10 million, or $5 million if the transactions were entered into 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. See CEA Section 1a(18).

3. Adopting Release at 42439.

4. The Dodd-Frank amendment also includes any other person who is regulated by the Commodity Futures Trading Commission (“CFTC”), an appropriate Federal banking agency, the National Credit Union Association or the Farm Credit Administration. Additionally, the CEA and CFTC have extensive provisions relating to retail forex participants and transactions. See e.g., CEA Section 2(c)(2)(B) and (C) and CFTC Part 5 Rules. 

5. See 76 Fed. Reg. 41676 (Jul. 15, 2011) (“Interim Rule Release”).

6. Interim Rule Release at 41677; see also Adopting Release at 42444 (“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”).

7. Adopting Release at 42441.

8. Id. at 42442.

9. Id. at 42443.

10. Conversion trades were excluded from the definition pursuant to an interpretation issued by the CFTC in a joint rulemaking with the SEC in August 2012. Adopting Release at 42439.  See also Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping; Final Rule, 77 FR 48207 (Aug. 13, 2012).

11. Rule 15b12-1(a)(3).

12. Adopting Release at 42444.

 

Written by:

Dechert LLP
Contact
more
less

Dechert LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.