CFTC rules could be blow to retail currency traders

NEW YORK Feb 09 (Reuters) - Rules proposed by the regulator of U.S. futures markets to fight fraud in foreign currency trades are too restrictive for retail trading firms and could dramatically cut into the growing business, dealers said.

The Commodity Futures Trading Commission was given clearer authority last month, in farm legislation passed by Congress in 2008, to go after foreign currency (forex) trading scams being pulled off in the unregulated over-the-counter market.

Thousands of small retail investors have flocked to the forex markets after the credit boom, lured by the potential of better returns than offered by stocks and bonds. But many retail investors are unaware of a growing number of scams in the industry and of the high risk of trading currencies on margin -- a key feature in forex trading.

"It's a prudential measure to avoid a particular section of the client base from over-leveraging itself," said Steven Pearson, senior director of currency strategy at Bank of America Merrill Lynch.

Pearson added that the regulation is "somewhat consistent" with similar measures taken in Japan.

But to retail forex dealers, some of the proposed rulings are too restrictive and may jeopardize growth in the industry. As a result, they said, they may have to scale back operations in the United States, sending millions of dollars in trades and hundreds of jobs abroad.

"It's a real issue here -- we are talking of losses in jobs, tax revenues and competitiveness," said Joseph Trevisani, chief market analyst at FX Solutions, a forex dealer, in Saddle River, New Jersey.

FX Solutions is part of FXDC, a coalition of nine large retail forex dealers lobbying against some of the CFTC proposals.

The contentious point is the CFTC's ruling to limit the leverage available to retail customers on forex transactions at a ratio of 10-to-1, down from about 100-to-1.

With the new ratio investors would have to invest a larger amount to place trades of the same size, which would result in a smaller return or loss.

At the same time, it would make the U.S. forex market less accessible to individual and smaller investors, the dealers said.

"Efforts to promote transparency and prevent fraud are more than welcome, but I can't really see the connection between fraud and customers' leverage," said Trevisani at FX Solutions.

A 10-to-1 margin is still high when compared with average stock trading margins at 2-to-1 but a far cry from leverage of as much as 500-to-1 allowed in the U.K.

"Going to 10-to-1 from 100-to-1 almost reads like a typo. It's very low and very random," said Glenn Stevens, chief executive officer at Gain Capital Group, an independent provider of foreign exchange services.

Stevens said the ratio is out of step with international industry averages and would force the trades to move overseas.

The retail forex market in the U.S. generates about $1 billion in revenue per year, according to industry estimates. That figure, as well as trading volume, has been increasing more than 20 percent a year, as small investors tap the loosely regulated $3.2 trillion-a-day currency market.

GROWTH POTENTIAL

"The U.S. forex market has a tremendous potential, and we would like to expand that portion of our business here," said Andrey Vedikhin, chief executive at the London-based Alpari Group, which trades about $60 billion a year for institutions and individuals.

"But now we'll have to take a wait-and-see approach as the landscape for the industry may change considerably in coming months," he added.

According to Alpari calculations, the cash amount required to trade one standard lot of 100,000 in the euro/dollar pair would jump to $14,285.00 from about $1,428.50, based on recent spot prices.

Retail investors can open accounts and start trading with as little as $100 and the average size of most accounts stand between $2,500 and $3,000, according to industry estimates.

Currency trading returns have the potential to outperform lower yielding securities, such as bonds and even stocks, but volatility in the forex market is high. And unlike stock traders who often face rules on short-selling -- a bet that share prices will fall -- forex investors can easily go long or short currencies.

The CFTC is also proposing that persons who solicit orders, exercise discretionary trading authority and operate investment pools be required to register.

The rules "are important steps in implementing the additional consumer protections," CFTC Chairman Gary Gensler said in January.

CFTC officials were not available for comment. The agency will take public comments on the proposed regulations until mid-March.

(Additional reporting by Nick Olivari in New York and Tom Doggett in Washington; Editing by Padraic Cassidy)