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Japan eyes tighter leverage cap on forex trading

Proposal before regulator would lower limit on gearing from 25-to-1 to 10-to-1

Japan's financial watchdog is taking steps to limit retail investors' risk exposure in forex trading.   © Reuters

TOKYO -- Japan's Financial Services Agency is considering lowering the maximum leverage allowed on foreign exchange trading by individuals as soon as this spring to curb risk taking.

The agency is studying a proposal to bring the leverage cap from 25-to-1 down to 10-to-1, based on trends in historical market volatility. The change would increase the margin deposit required for trading the same amount of currency by 150% and lower the potential for investment gains.

Forex traders use leverage -- in essence, money they do not have -- to magnify their gains. But it can have the opposite effect when the market moves against their positions. 

When a forex broker takes a trading order from a customer, it is required to place an order for the same amount and currency pair with a bank or another party to ensure it stays neutral with respect to market risk. But in some cases, these cover transactions are not used as much as they should be, the FSA has found.

The FSA also plans to raise the required capital adequacy ratio for forex brokers to deepen their buffers against losses during times of heightened market volatility. Brokers are now required to maintain a ratio of above 120% or face regulatory action. But the failure of a counterparty on a cover transaction can trigger a situation in which multiple brokers fall below the required level.

The agency will set up on Tuesday an expert panel on risks for over-the-counter retail forex brokers to discuss the proposed changes.

This year marks 20 years since deregulation in April 1998 opened up forex trading to individuals and businesses at large. Forex trading in Japan exceeded 5 quadrillion yen ($46 trillion) in 2015 but shrank 17% on the year last year to around 4.3 quadrillion yen. Retail investors appear to be turning to cryptocurrencies for their greater volatility.

An executive at a major forex broker voiced concern that the tighter regulations reduce the appeal of forex trading and lead to a further decrease in customers.

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