Forex Regulations

In June of 2012, a proposal by the National Futures Association requiring stricter regulation of PAMM accounts went into effect, sending many money managers and CTAs scrambling for PAMM account alternatives.

A PAMM account, or Percentage Allocation Management Module, is simply a way for investment management firms and CTAs to manage individual investor accounts more efficiently. Multiple individual accounts are aggregated into one “Master Account,” which is traded by the money manager or CTA. It is operated as one pooled account and the P&L is divided equally among the investors based on their equity in in it.

In April of 2012, James Bibbings, a former NFA supervising auditor, wrote a very informative post discussing the implications of the pending proposal. Appearing on SeekingAlpha.com, the post explained how the NFA felt PAMM accounts too closely resembled Commodity Pools, without being registered as such.

The points they brought up described multiple instances of structural problems. Issues with liquidity and margin were posing risks to investors and contributing to questions about the fairness of the division of P&L among sub-accounts. In the proposal, the NFA recommended the restructuring of PAMM accounts as a means of eradicating any dangers they could cause participating investors.
Bibbings also notes that PAMM scrutiny has reached the state level. Pennsylvania state security regulators saw the PAMM allocation system as a mechanism that was generating a “synthetic securities product.” This view made PAMM accounts subject to many additional securities laws and regulations in Pennsylvania, and could do so in other states, too.

At the time of Bibbings post, things weren’t looking good for PAMM accounts as they fell under intense regulatory scrutiny. Two months later, after the proposal took effect, “traditional” PAMM accounts began disappearing to make their necessary compliance changes. Some companies have seized the opportunity to create PAMM alternatives and others offer consulting services to help existing PAMMs comply with the new rules.   These instruments play an integral role in providing CTA’s and Money Managers with the key benefit of PAMM accounts: centralized management.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

There's a lot of talk these days about inflation and the impact of Fed policy on the dollar and the extension through the weaker dollar into higher commodity prices. Those looking to flame the Fed for its quantitative easing (QE) and generally loose monetary policy point to the falling dollar as the cause for oil going up above $100 and gold crossing $1500. While it's certainly true that the greenback is lower (the USD Index has been as much as about 12% off it's January peak), is the weak dollar really to blame for things like the rising cost of gasoline at the pump? Let's take a look at what the charts have to say about it all.

First is a comparative chart of oil prices in dollars and oil priced in euros. The chart below covers the last year's trading. The red line is the dollar value of a barrel of oil, referencing the left scale. The black line is the euro price of a barrel off oil (using front month futures), with that price on the right scale. Both scales are logarithmic so they express similar percentage moves between noted levels.

Now, the chart above doesn't show relative % gains for oil in the two currencies. Those are +31.3% in USD terms and +22.6% in EUR terms. This is about what we'd expected given the relative performance of EUR/USD over that time. The point of the chart is that aside from wiggles where oil has done better in one currency than the other for a period of time, the pattern of the two lines is consistent. Oil has been moving higher in roughly the same pattern, regardless of what currency we're talking about.

Now let's take a look at gold (again front month futures). Once more, the red line is in dollar terms and references the left scale, and the black line is euro terms referencing the right scale.

In this case, gold is up 29.6% against the USD and 19.4% in EUR terms. Again, that difference can be explained by the change in EUR/USD over the last year, which is as it should be. Here, though, we see a lot more variation in performance. In dollar terms gold has been in a fairly steady uptrend with only two relatively minor retracements. In euro terms, however, the ride has been much more dramatic. Those periods when the EUR line diverges considerably from the USD line are periods when EUR/USD was selling off.

The chart below highlights the variation between how gold and oil trade relative to the dollar. It shows EUR/USD on the top with the correlation between EUR/USD and gold plotted in red and the one with oil plotted in green.

Notice how much choppier the green line is than the red. That means the correlation between oil and EUR/USD is much more fickle than the one between EUR/USD and gold. That said, however, oil has spent more time with a positive correlation (meaning rising oil with rising EUR/USD and falling oil with falling EUR/USD). The gold correlation has been much more balanced. In particular, the gold correlation has been more negative when EUR/USD is falling.

Now, correlation does not mean causality. It just shows how similar the movement patterns are without looking at why that might be. The way I would tend to read the above, however, is to say that rising gold is more a factor of what's happening in the currency arena than rising oil prices. If you think about the implications of increasing money supply (which is what loose monetary policy is), then it makes sense. Gold is something with what could essentially be called a near fixed supply (very slowly increasing), so the more dollars there are the higher the value of gold per dollar (or any other currency). Oil has a different dynamic which is must more closely tied to economic considerations and geopolitics.

Reminiscent of when China used to announce their monetary policy decisions during the North American trading session Germany indicated on Tuesday afternoon that they are looking into banning short-selling on certain securities. Yet another reason to trade foreign exchange. If you want to short the Euro then just find your preferred FX broker and short the Euro against any currency that you want. If you want to discuss which currency that you should have shorted the Euro against then hop on Currensee and discuss it with the community or your team members.

Why is Germany making such a decision in the first place? Debt. It has been all about debt since the credit crisis began in 2007 and right now the worry is over European debt and one can only guess when it will end. At the moment countries with large fiscal deficits and debt to GDP ratios are being punished or should I say that these countries are hampering the global markets right now. This begs the question on why the US Dollar is doing so well when we all know that the US is laden with debt itself. Furthermore why is it so important for these countries to rectify their debt problems now and not leave this pile of debt for the generation behind them?

Lets first take a look at the US population. The reason will be evident later. In 2001 the UN projected that the US would have 321m people at the end of 2015. Per the US Census the US already has 309m thus it is well ahead of the forecasted pace. In 2050 the US is projected to have 397m, so a 28% growth rate from current day. The fact that the US has doubled its population since 1950 I’d guess that the forecast of 397m is well on the conservative side. More likely to be 425m - 450m by then for many well known reasons.

Compare that population growth to the well known European countries that are having trouble with their debts right now. Greece currently has just over 10m people living there. That is expected to decline by 16% in 2050. Italy has close to 60m people and that is expected to fall to nearly 40m. Talk about needing tourism. Portugal and Spain have similar UN forecasts in terms of declining population although they should each receive a bit of assistance from those that that bought 2nd dwellings in their countries over the past decade and with the proliferation of cheap airfares to these locals. Ireland is the only country where growth is expected and that is at a whopping 39% for the tiny country of 4m.

How about the country that seems to be paying for Greece’s miscues, Germany? Their population growth is expected to decline in the future. These are forecasts so they are doomed for error but unless the current trends change the respective tax bases in Europe will be declining. The US has a chronically high debt to GDP level as well but as mentioned its tax base is expected to grow quite substantially. As long as these trends remain in place and markets are worrying about debt then the US will remain a safe-haven and parts of Europe will be in need of assistance.

This report is for your information only and does not constitute investment or business advice or an offer to buy or sell securities.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.

This week Germany has announced a variety of measures to combat what it regards as unfair manipulation of markets by those in a position to short sell a variety of instruments. Once again this typifies the attitude that it is the market that is at fault and not Central Banks and Governments. I find it somewhat incredulous that this has extended to the sales of certain financial stocks, when a glance at the market shows that the Dax is still up on the year. It begs the question what would happen if the market actually did turn negative. The history of intervention is awash with failure down the years and whilst they often create temporary respite, the dominant theme and therefore trend that the market dictates usually quickly re-asserts itself. When the Sec banned short selling on Sept 19 2008 a 450 point one day rally in the Dow to 11,500, saw the market then collapse to 7900 just 3 weeks later. Obviously those naked short sellers couldn’t have been the reason. Neither for that matter, was the panic and huge falls of May 6 this year the result of a fat finger as was muted at the time. Thus far they cannot find a reason. I can give them one. Panic and a complete lack of faith in the ability of Governments and regulators to get there act together.

Once again the powers that be fail to see the folly of there own policies. The faults in the Euro zone are obvious to all apart from those who hang onto a flawed dogma. The market was led to believe that the Greece bailout was to the tune of 30 billion, but it didn’t believe this and punished Greece and the Credit Default Swap market. Then, low and behold the bailout suddenly becomes 100 billion, with another 450 billion plucked out of thin air in case there was any other countries being economic with the truth about there attitude to debt. Is it any wonder that the currency fell?

The reality is that the markets are there to provide the reality check and expertise in understanding the fault lines and weaknesses in the Global economic system, and whilst markets overshoot when panic sets in, prompting cries of the evil forces that would destroy, the regulators and politicians are happy to see markets overshoot equally when the outlook is viewed through rose colored glasses.
Therefore whilst some measure such as providing circuit breakers to excessive short term falls makes sense and moves to take certain OTC markets into the exchange traded world can also be viewed as a positive, more blanket measures to curb what is regarded as rampant speculation are counter productive. The irony of the latest Hedge Fund directive from the European Union, when viewed against the move to Mifid which has caused large scale market fragmentation in exchange traded instruments and the creation of dark pools is obviously lost on them. All politicians and regulators would be best served to be reminded of the law of unintended consequences before looking for someone other than themselves to blame.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.

This week the New York County Lawyer's Association (NYCLA) hand-delivered a 5-page letter to the CFTC detailing their comments to the controversial proposed rulings. Gotta love it when the lawyer-types get in on the action.

The two main rules they are opposing are

  • Proposed rule 5.9 regarding 10:1 leverage because it could have a significant and negative impact on the retail Forex industry
  • Proposed rule 1.10 regarding guaranteed IBs on the ground that it is anti-competitive and places and undue burden on Forex IBs

We couldn't agree more, especially as it relates to the guaranteed IB ruling 1.10. Their letter states the case brilliantly.

Although the Commission's rationale is compelling, there appears to be an inconsistency between the Commission's purported goal and the means by which it proposes to achieve this goal. The Rules effecitvely create two classes of IBs - those who introduce off-exchange retail Fore customers to counterparties ("Fore IBs") and those who introduce customers who trade exchange-traded futures contracts to counterparties ("Futures IBs") - and subjects these classes to differential treatment.

The letter goes on to address the Commission's objective for the Proposed Rule 1.10 - to reduce fraud in the marketplace.

There appears to be no clear correlation between a reduction in incidents of fraud and the requirement that Forex IBs be guaranteed. In fact, mandating the registration of Forex IBs alone could suffice in in meeting the Commission's stated objective. As the NFA has bulicly acknowledged, the buld of enforcement activity occurs amongst unregistered industry participants.

In the letter we submitted to the CFTC, we take the IB ruling one step further as it affects customer choice.

If adopted, the guarantee requirement will interfere with the legitimate activities of many Forex IBs, including those signing this comment letter, which have introducing relationships with multiple forex dealers. We fail to see how customer protection interests are served by denying customers access to Forex IBs that help them make informed decisions about where to trade Forex or by creating circumstances under which every Forex IB will face an inherent conflict of interest between representing the best interests of its customers and the commercial interests of the dealer on which it must rely exclusively for its business survival.

If passed, these rulings will affect the way you trade, the way you are handled as a customer and the choices you have as a trader. The CFTC will make their decisions based on how they think it will impact you. The comment period has ended and they are deliberating in a chamber somewhere. Let's hope that all of the efforts to help the CFTC see the negative impact of the regulations on traders like you and I are heard loud and clear.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.