Regulator to Review Leverage Limits for Currency Trades

By Andrew Ackerman 

        WASHINGTON--Regulators and currency-dealing firms are considering whether to boost requirements on borrowed money used by mom-and-pop investors after an unexpected surge in the Swiss franc left traders and brokers with steep losses.
        The National Futures Association, a self-regulator responsible for policing the futures industry, said it is considering whether to alter a cap on borrowed money, or leverage, for currency bets in response to last week's market tumult, according to spokeswoman Karen Wuertz.
        Brokerage Interactive Brokers Group Inc. said Tuesday that it expects to increase margin requirements, the amount of collateral investors must provide up front as a percentage of any trade. The firm said clients lost about $120 million on Thursday after the franc surged against the euro and other currencies. The broker is unlikely to recover those losses, Chief Executive Thomas Peterffy said.
        Foreign-exchange brokers like FXCM Inc. suffered huge losses after the Swiss National Bank moved on Thursday to stop reining in the value of the franc against the euro. FXCM on Friday accepted a $300 million, two-year loan from Jefferies Group LLC parent Leucadia National Corp. to cover client losses stemming from the move.
        On Tuesday, FXCM's shares tumbled 87%, to close at $1.60, after the shares traded on the New York Stock Exchange for the first time following the rescue loan.
        The losses at companies like FXCM were exacerbated by their business models, which allow clients to borrow huge sums of money to make foreign-currency bets. The use of leverage resulted in FXCM's clients--mainly small, often highly leveraged individual investors--owing the firm $225 million, putting the company in danger of violating regulatory capital requirements.
        The loan will keep FXCM in business, but at terms that will leave shareholders with just a sliver of future profits, some analysts said. FXCM will pay up to 17% annual interest, and Leucadia can force a sale of the company after three years. Overall, FXCM will end up paying as much as 82% out of future profits to Leucadia over the course of the loan, said Richard Repetto, an analyst at Sandler O'Neill + Partners.
        Meanwhile, dealers outside the U.S. are attempting to claw back funds from individual investors who ran up losses in excess of the cash deposited in their brokerage accounts. Danish broker Saxo Bank has given some clients until the end of the week to pay back funds.
        The National Futures Association and Commodity Futures Trading Commission rules cap leverage at 50 to 1 on major currencies like the franc, meaning an investor putting up $1,000 could borrow as much as $50,000. It was unclear Tuesday if the CFTC, which oversees the futures association, would revisit its leverage caps as well. The agencies have two separate sets of leverage rules that mirror each other. A spokesman for the CFTC didn't respond to a request for comment.
        Any changes to the future association's leverage rules, which its board plans to discuss Feb. 19, would be aimed at ensuring they are consistent with those at exchanges that trade similar foreign-exchange products, Ms. Wuertz said. The self-regulator is working on an analysis and didn't have any conclusions to share publicly Tuesday, she said.
        Individual investors began entering the $5.3 trillion-a-day foreign-exchange market in the late 1990s, when the first retail platforms gave clients affordable access to currencies. For years, brokerages catering to them operated outside of significant oversight and were magnets for fraud. That all changed with the 2010 Dodd-Frank financial law, which for the first time gave U.S. regulators authority over the brokerages. The law mandated a sweeping set of rules on the firms, such as capital requirements, as well as leverage limits on trades.
        Efforts to tighten the requirements are almost certain to encounter resistance from the industry, which successfully fought back an initial attempt to impose a 10-to-1 leverage cap in 2010. Even the 50-to-1 limit has generated controversy from critics as being too onerous.
        Adrian Frost of Kansas City, Mo., was one of the thousands of small investors around the world shellacked by the Swiss move last week. Late Wednesday after work, Mr. Frost logged in to his trading account at FXCM and placed a modest bet that the value of the Swiss franc would fall. Content with a wager that put just 3% of his trading account at risk, he went to bed.
        The currency appreciated so rapidly that by Thursday morning half of his account, or $1,000, was gone. "Holy God. Who could think this was possible?" said Mr. Frost, 39 years old. The part-time trader, who blogs about trading under the pseudonym "Arbitrager on Acid," runs an accounting firm, Red Eagle Services.
        James Ramage, Juliet Samuel, Tommy Stubbington and Chiara Albanese contributed to this article.
        Write to Andrew Ackerman at andrew.ackerman@wsj.com
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        (END) Dow Jones Newswires

        January 20, 2015 19:06 ET (00:06 GMT)

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