The US Commodity Futures Trading Commission (CFTC) said on Thursday it has charged forex market leader Forex Capital Markets (FXCM) with undercapitalization, failure to timely report its undercapitalization violation, and guaranteeing against customer losses at the time of the crisis with the Swiss franc (CHF) in early 2015. The regulator filed on 18 August, 2016, a civil enforcement action against FXCM in the US District Court for the Southern District of New York, where the broker is based.
As a result of the unpegging of the CHF from the Euro (EUR) in January 2015, when the markets went crazy and many brokers fell deep in trouble, FXCM had liabilities that exceeded its assets by some $175 million, putting its clients’ funds in great risk. The broker admitted to the gap only after it was contacted by the relevant US regulators.
In its claim, the CFTC seeks civil monetary penalties and a permanent injunction against future violations of federal commodities laws, as charged.
Following is an excerpt of CFTC’s statement:
“The CFTC Complaint, filed on August 18, 2016, alleges that FXCM, as an RFED in the business of offering or engaging in retail off-exchange foreign currency transactions, was required to maintain adjusted net capital of approximately $25 million on January 15, 2016. However, the Complaint alleges that on that day FXCM admitted it had a shortfall of at least $200 million under its adjusted net capital requirement, meaning FXCM had liabilities exceeding its assets by approximately $175 million.
As alleged in the Complaint, the capital shortfall followed the removal of the 1.2000 EUR/CHF fixed exchange rate, also known as the “peg,” and the drop of the EUR/CHF rate to 1.1659. FXCM’s systems were not designed to prevent or diminish the effects of such a market event, leading to increased losses. FXCM’s capital shortfall was not resolved until January 16, 2015, when FXCM sought and obtained a loan of approximately $279 million from a large conglomerate holding company, according to the Complaint.
The Complaint also alleges that FXCM failed to immediately notify the CFTC when it knew or should have known that its adjusted net capital was less than that required under the applicable CFTC regulation and that it was, therefore, undercapitalized. In fact, FXCM never affirmatively gave notice to the CFTC, and it was only after the National Futures Association (NFA) and the CFTC initiated contact that FXCM provided notice of its capital deficiency, according to the Complaint.
The Complaint also alleges that FXCM had an advertised policy of zeroing out negative customer balances, effectively guaranteeing customers against loss in contravention of CFTC regulations. FXCM’s policy of zeroing out negative customer balances was memorialized in FXCM’s customer account opening documents, which had a provision stating that if the customer incurred a negative balance through trading activity FXCM would credit the customer account with the amount of the negative balance, according to the Complaint.”
In January 2015 Swiss central bank unpegged the Swiss frank (CHF) from the Euro (EUR). The markets saw exceptionally high volatility and low liquidity after the EUR/CHF pair collapsed. The US broker clients experienced heavy losses and generated negative equity balances of combined some $225 million. This put the broker in breach of the regulatory capital requirements. After the CHF-related crisis, in order to resume operations normally FXCM was forced to draw a $300 million cash credit from US-based lender Leucadia National Corp. and to sell its subsidiaries FXCM Japan Securities and FXCM Asia, aka FXCM Hong Kong, to its Japanese peer Rakuten Securities.
The CFTC’s move comes 19 months after FXCM did the said misconduct. Why the regulator has decided to take action now is not clear.
At the same time, the news comes shortly after the regulator imposed new laws that seriously restrict the participants on the already strongly consolidating retail forex market in the US. Forex brokers that offered retail services in the US have decreased to five in total – FXCM, Gain Capital, Oanda, Interactive Brokers, and TD Ameritrade Futures & Forex. As of this fall, however, regulatory amendments are restricting brokers and FXCM, Gain Capital and Oanda will be the only ones allowed to offer retail forex trading in the country. Interactive Brokers already announced that it is restricting its services to US clients.
FXCM is a registered futures commission merchant (FCM) and a retail forex dealer (RFED) with the US Commodity Futures Trading Commission (CFTC). It has units registered and regulated with the relevant authorities in the US, the UK, Australia, and France.