Proposed Rule

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EXPLANATION OF PROPOSALS

A) Explanation of Proposed Amendments to NFA Bylaw 301(i):

NFA Bylaw 301(i) as written did not contemplate electronic communications and consequently technically requires official NFA communications to be delivered in writing to Members. To facilitate the use of email for delivery of routine communications, the Board amended Bylaw 301(i) to clarify that an email communication to a Member is an acceptable form of delivery for official communications if:

  • the Member has provided an email address for that purpose; and

  • another rule does not require the particular communication to be written or in some other form, e.g., notices provided in the Online Registration System, disciplinary complaints, and registration notices.

B) Explanation of Proposed Amendments to NFA Bylaw 1301(b):

With the implementation of the Commodity Futures Modernization Act of 2000, several exchanges have considered offering new products that do not fit squarely within the historical framework relating to how futures contracts are traded, cleared and processed. NFA was recently questioned how NFA's assessment fee applies to OTC cleared transactions that are subsequently converted to futures.

To date, NYMEX is the only contract market that has adopted rules to offer OTC contracts that are entered into outside the exchange matching facility, and then submitted to the exchange's clearinghouse where they are converted to futures contracts. These OTC transactions become futures positions subject to margin, segregation, position and accountability reporting requirements, and are afforded bankruptcy protections under the CFTC's Regulations. Moreover, these contracts are carried by FCMs as futures positions, and can easily be offset through delivery or an opposite EFP. Therefore, once these contracts are converted by NYMEX's clearinghouse to futures, they are treated for regulatory purposes as futures. Currently, NYMEX's clearport system offers 34 OTC contracts that are subsequently converted to cash settled futures contracts.

NFA has previously taken the position that futures positions that are initiated on a contract market but closed out through an EFP are "round-turn" transactions subject to the assessment fee. On the other hand, the current language of NFA Bylaw 1301(b) states that FCM Members shall pay the assessment fee for each commodity futures contract traded on a contract market. Since these OTC transactions are not traded on a contract market, one could take the view that although the OTC contracts are subsequently converted to futures contracts, the transactions are not subject to the assessment fee.

The Board determined to amend Bylaw 1301(b) to clarify that these transactions are subject to the assessment fee. NFA Bylaw 1301(b) was written at a time when these types of contracts were never anticipated. The Board believes that these OTC contracts have all the attributes of futures contracts except the manner of execution. Since the Board has taken the view that futures positions that are initiated on a contract market but closed out through an EFP are "round-turn" transactions subject to the assessment fee, it believes that no difference should exist for purposes of imposing the assessment fee based upon whether the futures transaction is the initiating or closing transaction.

C) Explanation of Proposed Amendments to Interpretive Notices:

The CFTC recently amended Rule 1.35(a-1)(5), which allows certain account managers to bunch customer orders for execution and to allocate them to individual accounts at the end of the day. Due to the CFTC's amendments to Rule 1.35(a-1)(5), NFA staff reviewed its two interpretive notices regarding bunched orders. The Board determined to revise NFA's 1997 interpretive notice currently entitled "NFA Compliance Rule 2-10: The Allocation of Block Orders for Multiple Accounts." The amendments to this interpretive notice reorganize the original notice, make it consistent with the CFTC's amendments to Regulation 1.35(a-1)(5) and continue to provide important guidance relating to the use of bunched orders. For example, the amendments to the interpretive notice continue to:

  • Require CTAs to use an allocation methodology designed to provide non-preferential treatment for all accounts (the specific allocation instructions may change daily based on certain factors, but the allocation methodology should not);

  • Provide guidance on the type of allocation methodologies designed to provide non-preferential treatment;
  • Require CTAs to analyze each trading program at least quarterly to ensure that the allocation method has been fair and equitable (i.e. customers in the same trading program achieve similar results over time) and to document this analysis; and

  • Remind FCMs that they have certain basic duties to their customers in connection with these orders.

The Board also determined to delete NFA's 1999 interpretive notice entitled "NFA Compliance Rule 2-10: Orders Eligible for Post-Execution Allocation," as it no longer applies.

In late June, NFA formed a subcommittee comprised of FCM, exchange and CTA representatives to review the proposed changes to these two interpretive notices in light of the amendments to CFTC Regulation 1.35(a-1)(5). This subcommittee provided very helpful comments that were incorporated.

As mentioned above, NFA is invoking the "ten-day" provision of Section 17(j) of the act and will make these proposals effective ten days after receipt of this submission by the Commission unless the Commission notifies NFA that the Commission has determined to review the proposals for approval.

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