Financial Health of Forex Brokers

October 16, 2006

I received a follow-up email from the DCIO or the Division of Clearing and Intermediary Oversight, a legal arm of the Commodity Futures Trading Commission. My questions were:

How can the data (FCM merchant report) best be interpretated to conclude the financial health of a broker?
What would be grounds for a broker having to halt operations based on the data from this report?

Their response, which was from the Special Counsel was long but the information indispensable. Click [Read More] to read their entire response.

The 2 important points I got from the response were:

The FCM report that shows a firms net adjusted income is not totally indicative of financial health mainly because, in her words, "a firm's transactions and positions (proprietary or customer), exposed to market events can impact capital levels quickly." This is very similar to our (we traders) capital levels in a high risk market such as foreign exchange. Market events can impact our balance quickly.
Similar to the Refco situation, in her words, "should an FCM with liabilities to customers for off-exchange retail foreign currency have to halt its operations due to a loss of capital, those customers may be left in the position of unsecured creditors of the entity with respect to trying to collect anything from the FCM."

The scary thing is that even though Forex retail firms keep customer funds separate from operating funds, your funds are subject to seizure from creditors first, which I'm sure Refco customer are well aware. This needs to change and additional regulation should be adopted to counter this.

[Read more]