Dodd-Frank FX Deadline Costly to SEC Firms

Posted originally on July 1, 2011 at the Aite Group Blog

Dodd-Frank has opened a door to U.S. banks to offer retail currency trading (aka FX or Forex) as of July 22, 2011, but is about to close that same door to U.S. securities firms. Although theoretically securities firms will still be able to offer FX, the Securities and Exchange Commission is not likely to pass retail FX rules by the July 15 deadline to prevent its registrants from being shut out of FX, a lucrative business with significant growth potential.

Some firms affected by this likely SEC inaction include Charles Schwab, T.D. Ameritrade, E*Trade, and Interactive Brokers. As of July 16, only a dozen or so CFTC-registered FX dealers and Citibank (the only registered bank for now) will be able to offer retail FX to clients. To our knowledge, CFTC-registered futures commodity merchants (FCMs) not registered as a retail foreign exchange dealer (RFED) will also have to stop offering retail FX.

SEC firms currently offering retail FX like Interactive Brokers and CFTC-registered like MF Global will have to refer retail FX business to authorized firms. It is hard to quantify the potential loss in assets and trading revenue for these firms, but it is likely in the millions. For the big securities firms that were just starting to operate in the business, like Charles Schwab through OptionsXpress and TD Ameritrade through thinkorswim, the losses will be considerable.

The options the SEC has at this point are three: 1) do nothing and let what was described above occur — this is the most likely outcome; 2) approve FINRA regulation 09-06 “as-is” or with modifications; and 3) pass its own set of retail FX rules without a comment period – Dodd-Frank allows regulators the flexibility to pass rules without public comment if required by the lack of time or resources. If the SEC does decide to pass new retail FX rules (which would be the right decision in this author’s view), these rules will likely be similar to what the CFTC has passed, and would level the playing field across regulators and not put SEC registrants at a disadvantage.

SEC broker/dealers (B/D) have no options in this matter, but there is a caveat. While the CFTC prevents SEC B/D from circumventing the law and offering retail FX as a FCM BD, there is nothing that would keep the parent of the B/D to register a RFED entity, or even to use some of the backoffice staff of the B/D for the new RFED. Securities firms that have banks in their operating group could use those banks as a way to offer retail FX as soon as these units are approved by the Office of the Comptroller of the Currency and FDIC to do so.

Of course, there are more intricacies than those we can explain here, but the good news for SEC firms is that they could still participate in retail FX outside of the SEC — if it comes to that.

NB. On the 11th hour (July 13, 2011), the SEC released "temporary final" rules for retail FX, thus averting the issues raised on this entry.