There will be light posting from me, the putative centrist of this fun bunch, until after the weekend. Work, travel for work, more work, blah, blah, blah. I promise a post on “Why I Hate Howard Dean” early in the next week, which should spice things up since I’m blogging with certified-Dean-Lover Katherine.
In the meantime, let’s turn our attention to the intertwined worlds of finance and crime. Here’s a brief roundup: Martha’s in trouble.* Enron is going nowhere, but its attorneys are doing just fine.** And FBI agents arrested 48 foreign exchange brokers in connection with a probe into securities and currency fraud. Currency trading: the last frontier of the financial world, a wild west largely devoid of regulation. Expect the SEC to do some conquerin’ right quick.
*Not to be confused with the cry that oft echoes through the halls of the Police Academy: “Mahoney‘s in trouble!”
**Old article, but situation remains unchanged.
UPDATE: Bjurk notes in comments that I confused my regulating bodies in the last line in the body of my post: “currencies themselves aren’t securities (so no SEC regulation) and they’re not commodities because they don’t fit into the Commodity Exchange Act’s definition–but, in the US, futures and option contracts on currencies are regulated by the Commodity Futures Trading Commission (“CFTC”).”
Bjurk and Toby provide further argument/analysis in the comments.
I may be a certified Dean lover but are you a certified Police Academy quoter?
It’s a good thing you didn’t post on the subject yesterday. You could’ve gotten quite a reply, between one thing and another.
my html is god awful so apologies in advance
“Currency trading: the last frontier of the financial world, a wild west largely devoid of regulation. Expect the SEC to do some conquerin’ right quick.”
While I will admit that the fx market needs regulation I dont think the SEC will have any formal control on the US FX market anytime in the near future. SEC has been trying to expand their charter to incude the FX markets for sometime now – and thus far have been unsuccessful largely due to the efforts of banks and brokerage firms.
Being the first country establish a regulated FX market will send that business offshore (or at least to the UK and Japan) in a heartbeat. I just dont see it happening until both Japan and the UK agree to set up similar governing bodies. I think that will be a hard sell.
Being the first country establish a regulated FX market will send that business offshore (or at least to the UK and Japan) in a heartbeat. I just dont see it happening until both Japan and the UK agree to set up similar governing bodies. I think that will be a hard sell.
I hadn’t considered the need for international coordination in regulating this area, Toby. Thanks for bringing it up.
I’m not sure, however, that the threat of offshore flight really is as bad as you suggest. Off-shore stock markets and other financial devices, many of which are regulated to a far lesser extent than the U.S., haven’t driven people from the U.S. market. I take your point regarding Japan and the UK, but isn’t it equally plausible, in this post-Enron era, that many consumers will actually prefer a regulated environment, and that their dollars (and yen and pounds and euros) will flow accordingly?
As for this —
SEC has been trying to expand their charter to incude the FX markets for sometime now
It seems to me that the latest arrests are an opportunity for the SEC to press its case again.
Ok, so perhaps sending it all offshore is an overhasty statement. lets throw that away for now.
I also wrote the following response pretty quick because the phone wont stop ringing. I apologize if it isnt well thought out.
the subjective nature of the FX markets will make it difficult to regulate in a reasonable fashion (using the US stock and future markets). One bank can quote a particular currency at two different levels (which is usually caught and taken advantage of internally). But catching an “arb” from [insert name of big internation bank] can happen.
Stock and future markets have single bid/offer levels that fluctuate. high volume FX markets (USD, GBP, JPY) have multiple bid offer levels that fluctuate bank to bank and sometimes from market maker to market maker within a single bank (one market maker at tullet may quote USD.JPY 130.87 – 92 while another market maker on a different tullet desk could quote USD/JPY 90-95). That is part of the problem, and yet really important to how traders make money.
if you suddenly try and ensure that each buyer is matched to each seller and that the buyer and seller are not one and the same you could be forcing losses onto an institution when they have internal arbs.
And that really is the focus of regulation goals. To ensure that buyers and sellers are not being matched internally. The vast majority of the the 1.2 trillion dollar market is done bank to bank behind the scenes – you or I would never see it happen or be invited to play.
so when the washington post quotes this:
“The criminal charges announced today allege fraud and other criminal offenses by key players at virtually every level of the foreign currency markets.”
all I can say is hogwash. the people that take advantage of the system are not the giants. big players sure, but not the giants. and forcing regulation on the entire market because a small fraction of the playing field rip off their clients is going to be really hard to justify.
“Currency trading: the last frontier of the financial world, a wild west largely devoid of regulation. Expect the SEC to do some conquerin’ right quick.”
Not true.
currencies themselves aren’t securities (so no SEC regulation) and they’re not commodities because they don’t fit into the Commodity Exchange Act’s definition–but, in the US, futures and option contracts on currencies are regulated by the Commodity Futures Trading Commission (“CFTC”).
by way of background, FX transactions can take over-the-counter (inter-bank–remember that guy who brought down Barrings?) or on regulated exchanges (Chicago Mercantile Exchange, EUREX, LIFFE, etc.)
retail sale of OTC FX contracts is illegal–unless you are a so-called Eligible Contract Participant (individuals with net worth $10mm I believe). OTC participants are basically large sophistacated banks and hedge funds. FX markets are deep and liquid and the players generally know what they are doing.
for US retail customers, they can trade FX only on regulated contract markets like the CME. As such, they are subject to exchange rules and can only be sold by futures commission merchants–who are regulated by the CFTC.
to say this is the wild west really isn’t accurate.
taking a quick look at the complaints, they seem to be based largely on good old-fashioned fraud and illegal sale of OTC FX to retail customers in violation of CFTC rule.
I sux at html–but here is a link for you nerd lawyers in the crowd.
http://www.cftc.gov/opa/enf03/opa4867-03.htm
Also, offshore flight risk is very real for the futures markets. At a time when the SEC is hightening its scrutiny of the capital markets, the CFTC is relaxing its rules in order to stay competitive with non-US contract markets.
long rambling post–but my take on this is that rules to prevent what happen exist. The SEC will only be tangentially involved as this doesn’t fall within their jurisdiction. Regulatory oversight has been perhaps lax (CFTC is underfunded and understaffed), but I think making WSJ/NYTimes headlines will do much to correct this.
to quote burke because I know how now:
I 100% disagree burke. retail clients are not limited to trading currencies on the futures market. retail clients can trade FX through establish brokerage firms. This is part of the reason why regulation is becoming more and more of an issue. Its what I used to do for a living.
You see adds on CNBC type channels or in investors business daily etc. “with as little as a $500 investment you could have made $10,000 trading the Japenese Yen last year.”
a retail client can trade FX. They will not have direct relationships with banks and must have an account with a brokerage firm are rely on their established relationships.
tobias-
yes, you are correct. retail investors (widows and orphans) can access off-exchange FX–but only via a broker as a bank or other counterparty can only deal with eligible contract participants not widows and orphans. While more lightly regulated, this is still a regulated relationship. and it was under these regulations that our naughty traders got caught.
see this CFTC advisory on FX retail sales.
Glad you got out of the business before getting caught!
burke – this CFTC advisory addresses futures trading only. the entire document focused on currency commodities and options and does not address derivative markets – what I am calling FX.
It seems to me that this advisory just reminds people that it is illegal to trade futures off market and that setting up futures bucket shops is against the law.
I was under the impression that the traders getting arrested in nyc were doing shady things with derivative accounts – moving trades around, quoting bad markets etc to the benefit of their clients.
sure derivatives may be a futures of sort, but they are certainly not the type of futures naturally associated with CFTC. I think the only aspect of the CFTC advisory that would apply to a derivatives firm/trader/desk would be the anti-fraud regulations as they apply to account management/record keeping.
or perhaps 4 years later I am way way out of the loop.
Hey Bjurk, Toby:
See? This is what happens when I make flip comments about an area of the law I know nothing about: Honest-to-goodness securities lawyers and (former) traders emerge from the woodwork and perform tae-kwon-take-down-von.
Sheesh. Post is being updated.
I am really a fish out of water on this one. burke is way more up to speed on this stuff than I ever was or hope to be.
I just like argueing with him.
no, Toby–you get this stuff.
I actually read (honest to god, read) two of the complaints–damn you toby. there is nothing slick about what was done. in one case the traders solicited money from individuals on the promise of great returns on FX trading. They then took the money, put it in their pockets, and lied to the investors about what returns they were getting on trades they weren’t making. Eventually they just told the investors they lost all their money. sorry. if any trades were made, the traders were not eligible contract participants–so it was an illegal off-exchange trade.
In another case, there was a coordinated effort to defraud UBS. A rouge UBS trader intentionally loses a trade to a trader at another bank’s FX desk. That trader, who’s in on it, loses to an intra bank currency broker who in turn losses to an individual investor account (which causes an illegal off-exchange trade). The individual winner then splits the profits as everyone is in on the game and only UBS takes a hit. This was the “clever” one.
to answer your derivatives question–all futures contracts are derivatives as all a derivative is is a product that derives its value from an underlying asset.
In a colloquial sense, “trading derivatives” suggests a relationship between counterparties involving multiple, often complex, futures transactions.
A plain vanilla derivative transaction is like an interest rate swap–fixed rate for floating rate at designated dates (perhaps subject to a haircut) over the course of a period of time. These are most frequently done to hedge legitimate business risk–though obviously my clients do it purely for speculation. you can have a derivative product on pretty much anything–weather, energy, price of paper pulp–though must have some economic purpose to avoid state gaming laws.
what made that advisory relevant to this discussion is that it touches on how CFTC has jurisdiction over retail FX–it regulates the participants if not the trades themselves. It also shows the reason why as individuals we can’t hedge the interest rate on our mortgages–we’re not eligible contract participants and any derivative transaction we would want to enter into to hedge our interest rate risk would be an illegal off-exchange futures contract.
anyway, my whole point in all of this was to point out that saying FX and derivatives trading is an unregulated arena isn’t entirely accurate as the parties involved are (or should be) regulated–albeit lightly (there is an assumption of sophistication on the part of FX counterparties–though not retail public).
am now done polluting this fine blog with this stuff.
The intrabank (and related institutions) derivatives markets covers risks associated with Credit, FX, Interest with a whole host of nonregulated vehicles (forward contracts, swaps, swaptions, et al). These are non exchange contracts (not traded on the CME, CBOT, Life et al)and in part reflect that banking and financial services in general is a regulated industry (Federal Reserve and Comptroller of the Currency in the US, Bank of England and other Reserve Banks).
Turf issues abound.
Basle Capital Accords gives a nice overview of the new parameters which will govern banks.
just read the updates story in the Post. I see the CFTC joined the game charging 31 folks.
glad I got out of that line of business. I’ve seen enough to never trade futures or fx myself.