Retail FX: A question of leverage

Proposed regulations limiting the amount of leverage retail foreign exchange brokers can offer seem to be spreading fast - so fast there's the risk of curtailing the growth of this largely clean source of flow.

In the US, the National Futures Association plans to cap leverage offered by forex dealer members (FDMs) at 100:1 in the G-10 currencies and 25:1 in minor currencies. The Chicago-based industry body said the cap was due to concerns that higher leverage amounts could deplete a customer's account balance, noting some FDMs offer leverage as high as 700:1.

It seems the Japanese Financial Services Agency is following suit, with leverage possibly being capped at a dramatic 25:1. The implication for retail forex brokers was evident last Tuesday (March 27) when the share price of IG Group Holdings took a hit after Japanese press reports on the potential limit on leverage.

The London-based spreadbetting company acquired an 87.5% stake worth about $207 million in Tokyo-based FXOnline Japan last October, with expectations that the exposure to the Japanese business would increase the proportion of the group's revenue derived from non-UK clients from 27% to 39% on a pro forma basis (FX Week, September 29, 2008).

In response to the reports, IG issued a statement saying that, based on its understanding of the possible rule changes, the limit would only apply to a minority of the group's Japanese clients, measured both by number of clients and by trading volume. "While it is not possible for the group to quantify what impact, if any, the [Japanese] FSA's proposed methodology might have on the future trading activity of FXOnline's clients, the group would not expect it to have a material impact on the group's revenues or profits."

FXOnline contributes approximately 10% of IG Group revenue. The company said FXOnline already offers standard leverage levels substantially lower than some competitors in Japan and so will be affected to a lesser extent than those competitors. As such, it said, the restriction on the level of leverage that can be offered could be beneficial to FXOnline's competitive positioning within the Japanese retail FX market. Either way, it's just as well FXOnline is expanding its product range to contracts for difference and binary options, which won't be affected by any proposed limitation on leverage.

It should be interesting to see what the implications will be for liquidity providers in these markets.

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