There is this myth going around that NDD firms have no risk because they are "not market makers." It's time to put this myth to rest once and for all.
First, all firms, whether they have dealing desks or not, are required to set aside 10% of all customer assets if they offer 100 to 1 leverage. So a firm with $50 million in customer assets is required by law to already set aside $5 million just to meet that simple requirement. When added to the probable NFA rule change that firms set aside an additional $5 million in capital that means firms will need $10 million in capital as Currency Trader Magazine reported.
But getting back to the NDD 'no risk' myth. Here are just some of the risks NDD firms have to cope with.
1)Business Risk. All businesses have the simple risk of not having enough revenue to cover their expenses. Forex firms are no different. But since forex firms are holding customer funds the temptation of creditors to lay claim to those funds should a forex firm go out of business is too tempting. That is one reason the NFA wants forex firms to have more capital on hand than the average business in America. If a restaurant goes under the customers of the restaurant don’t feel the pinch since they just go to another restaurant. But customers of forex firms could lose their money on deposit if the firm they do business with goes under. Thus the risk is far greater to the general public.
2)Credit Risk. The reason behind Regulator's customer asset requirement rule (firms must set aside 10% of all customer assets) is because of the risk of customers defaulting on their credit obligation. This happens in futures all the time when accounts go negative. While forex firms like to brag about their platforms preventing customers from going negative the fact is it does happen. If the market drops 100 points in one tick it can easily happen. And if the firm can’t collect on that customer they have to eat that loss. That is a big risk. And with customers trading at 400 to 1 leverage in some cases the NFA is well justified in demanding firms have more capital on hand to offset that risk.
3)Market Making Risk. As much as NDD firms like to say they have no market risk because they pass along their trades to banks the fact is they still do have market risk. While that risk is not as large as non-NDD firms the fact is if the banks who execute each trade suddenly decide NOT TO execute a trade it is the NDD firm that has to take over pricing. Banks are not obligated by law to make prices the way exchanges are. If the market gets wild and the NDD firm’s bank decides not to make any prices who do you think is stuck with that responsibility? The NDD firm is. Either that or they don’t offer prices at all and basically cease operations. I would say that is quite a risk and certainly justifies a higher capital requirement as a result.
4)Market Discrepancy Risk. Trade discrepancies happen. There will always be cases where a bank says it executed a trade at one price while the counterparty says that trade was executed at another price. Since banks are loathe to admit guilt the onus of responsibility almost always falls on the counter party. And with high leverage those discrepancies can be very costly. Again, this justifies a higher capital requirement to help offset that risk.
So as you can see NDD firms have plenty of risk as well. They are not immune to the laws of economics. And as such are just as much in need of higher capital requirements as every other forex dealer.