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News Facts Actions - Fall 2011

In this issue:

A few minutes with NFA's newest officers, Ed Dasso and Jamila Piracci

The Commodity Futures Trading Commission's (CFTC) proposed rules regarding the regulation of Swap Dealers (SD) and Major Swap Participants (MSP) delegate to NFA the responsibility of processing applications for SD and MSP registration, conducting examinations and monitoring these new Member for compliance with the full range of CFTC regulations.

In addition, the CFTC has proposed allowing Swap Execution Facilities (SEF) to outsource certain regulatory functions to a registered futures association, such as NFA, or another registered entity.

Over the past several months, NFA has begun preparing to undertake these new regulatory responsibilities. As part of the process, NFA has hired two new officers: Edward Dasso as Vice President of Market Regulation and Jamila Piracci as Vice President of OTC Derivatives.

Dasso previously served as the Manager of Market Regulation for the InterContinental Exchange. He also previously spent several years at NFA as the Managing Director of Trade Practice and Market Surveillance.

Piracci came to NFA from the Federal Reserve Bank of New York. She has also served as Assistant General Counsel for the International Swaps Derivatives Association.

News,Facts,Actions recently sat down with both individuals for a brief discussion of their new duties, the challenges they face and their long-term goals for the organization.

What are some of the immediate challenges facing NFA as it begins to enter this new era of regulation?

ED: I feel one of our greatest challenges is managing projects that have so much uncertainty. At this point, we do not know when to expect the CFTC to publish its final rules regarding SEFs and what the timeline for implementation will be. Given this uncertainty, we have been in constant contact with the CFTC as well as our prospective SEF clients. At this point, we are focusing most of our efforts on technology so that we will be able to receive and analyze the data we expect to see from our potential clients once they become registered as SEFs.

JP: I feel one of the key challenges we have is developing the infrastructural support for registering, and monitoring the compliance of, SDs and MSPs under the requirements of the Dodd-Frank Act. The Act changes the landscape of the OTC derivatives market in significant ways, and we are working to develop the right substantive foundation for our new responsibilities. Related to this challenge is that of hiring senior level staff with risk, capital and swaps market experience. We have posted for positions that would fill these gaps and are making significant progress in interviewing very qualified candidates.

On a personal level, what has been the most challenging aspect(s) of your job so far?

ED: The most challenging thing for me is to remain patient. It's critical that we not get too far ahead of ourselves in developing new systems until we know more precisely what will be expected from SEFs. Right now we're remaining focused on providing pre-implementation services

JP: I consider the most challenging aspect of my job to be helping NFA minimize what (NFA President) Dan Roth has called the "dead zone" - that period of time when we might ramp up more quickly than CFTC rulemaking progresses - and being ready when we need to be open for business.

Although you've only been at NFA for a brief time, could you list some of the aspects of the corporate culture that give you confidence that NFA will be able to carry out its new responsibilities efficiently?

ED: Actually, this is my second time being employed at NFA. I was previously at NFA from 2000-2009. Given my prior experience as well as the last 8 months at NFA, I am extremely confident that NFA will provide the best regulatory services possible to SEFs. NFA staff has always had a "can do" attitude toward new responsibilities. Market Regulation works primarily with the Information Systems, Legal and Strategic Planning departments and in all instances staff represents a willingness to take on a task and provide solutions that exceed the expectations of our clients.

JP: My first encounter with NFA was as a young derivatives lawyer. When I had questions about NFA registration or rules, I felt that the organization had an open door to helping the industry meet its regulatory responsibilities. In my short time here as an employee, I have encountered countless additional examples of that and consider that cultural norm, exemplified by its leadership, to be a key component of building an excellent swaps regulatory program within NFA.

What are your long-term goals for your area?

ED: My long term goals for Market Regulation are to continue to provide the most efficient and exemplary regulatory services for our futures exchange clients (Designated Contract Markets) and to build a state-of-the-art swaps surveillance program for SEFs. At the end of the day, I want market participants and investors to have the highest level of confidence knowing  that NFA is providing regulatory services to futures and swaps markets on an independent basis with the goal to protect investors and ensure market integrity.

JP: My long term goal for the Swaps area is to provide swap dealers and major swap participants with expert self-regulation. Meeting this goal involves our rising to the challenges of building the right human and intellectual capital, as well as adjusting NFA's existing infrastructure to meet the needs of swaps related compliance. In addition, we will continue to nurture our relationships at the CFTC and other regulatory bodies and get to know our future members.

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NFA proposes change in forex fee structure

The continuing high costs of regulating NFA's forex Members, coupled with a sharp decrease in revenue from forex firms, have resulted in an NFA proposal to change the forex fee structure. The new fees - an increase in membership dues for non-Forex Dealer Members (FDMs), a new processing fee to recoup costs of NFA's forex trade monitoring system and an increase in FDM membership dues - were approved by NFA's Board of Directors in August and were submitted to the CFTC in September.

"We have taken these steps in order to comply with our Board's longstanding directive that NFA should recover its forex-related regulatory costs from our forex Members," said Dave Hawrysz, NFA's Chief Financial Officer.

Revenue from the Forex Dealer Member (FDM) assessment fee decreased approximately 40% between fiscal year 2009 and fiscal year 2010. In the following fiscal year, assessment fee revenue continued to decrease, this time approximately 30%.

"In assessment fee revenue alone, NFA has experienced a drop of nearly 60%," said Hawrysz. "We have lost additional revenue from forex membership dues and the additional surcharge we previously collected from FDMs on unregistered solicitors but eliminated last Fall due to the CFTC's forex registration requirements."

Although the amount of forex-related revenue has dropped significantly over the past two fiscal years, the amount of resources NFA devotes to regulating Members engaging in forex activities has remained relatively stable. This is in spite of the fact that since January 2010, over 150 forex IBs, CTAs and CPOs that introduce business to FDMs have registered with the CFTC and become NFA Members.

NFA's forex-related expenses also include the resources NFA devotes to enforcement cases involving forex Members. Over the past three fiscal years, approximately 32% of all complaints issued by NFA's Business Conduct Committee have involved FDMs and their intermediary IB, CPO and CTA firms. Forex Members make up less than 5% of NFA membership.

"All of these factors have resulted in a significant gap between revenue and expenses," said Hawrysz. "In order to make the forex regulatory program a self-sustaining program and attempt over time to eliminate the accumulated deficit we have already experienced, NFA must generate significantly more forex-related revenue."

NFA has proposed to increase forex-related revenue in three areas. First, NFA proposes to increase the annual membership dues for non-FDM Members engaging in retail forex activities from $750 to $2,500.

"We believe that these non-FDM Members should bear a greater share of the costs associated with regulating their forex business," said Hawrysz.

The second component of the fee increase relates to NFA's Forex Transaction Reporting Execution Surveillance system (FORTRESS), which NFA uses to monitor FDM trading practices on a daily basis. NFA proposes to assess a fee of $.002 on all order segments processed through FORTRESS. Currently, FORTRESS processes approximately 60 million order segments each month.

The final element of the fee change proposal is an increase in FDM membership dues. The FDM membership dues are based on the FDM's annual gross revenue. Along with the dues increase, NFA proposes eliminating the assessment fee that FDMs currently pay on each forex transaction, which has proved difficult to administer.

The full text of NFA's rule submission letter to the CFTC can be found here.

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NFA proposes new Interpretive Notice to address the allocation of bunched retail forex orders for multiple accounts

Citing concerns over the allocation procedure known as Percentage Allocation Management Module (PAMM) used by Commodity Trading Advisors (CTA) that manage retail forex customer accounts, NFA has proposed a new Interpretive Notice to address the issue. The Interpretive Notice was approved by the Board of Directors in August and submitted to the CFTC in September.

Utilizing PAMM, forex CTAs place orders for an unlimited number of customer accounts under one Master Account at each Futures Commission Merchant (FCM) or Retail Foreign Exchange Dealer (RFED) where the CTA is conducting business. Each individual customer maintains a sub-account under the Master Account. CTAs utilize the total equity of the Master Account to place a bunched order and then subsequently allocate lots based on each customer's account equity as a percentage of the overall equity in the Master Account. This method often results in allocations to individual customers that are not equivalent to a regularly offered and tradable sized lot or contract.

"During several recent NFA audits, NFA noted that many forex CTAs use the PAMM method to allocate bunched orders placed by them on behalf of multiple clients," said Compliance Director Lauren Brinati. "Upon further review, we came to the conclusion that the use of PAMM does not treat each sub-account as an individual account, does not appear to comply with the CFTC's interpretation of Regulation 1.35 and often does not result in the fair and equitable treatment of customer accounts."

Because the CTA places orders for regularly offered and tradable sized lot or contracts based on the Master Account's equity (not the margin equity of each individual account), some fraction of a regularly offered and tradable sized contract is allocated to each customer based upon their percentage in the master account.

"This practice makes it very difficult for an individual customer who has been allocated a percentage share of a lot or contract to offset the transaction," said Brinati. "The individual customer would have to wait until the tradable size lot or contract is offset for all customers at the Master Account level. We believe that this inhibits a customer's ability to close their account and have timely access to their funds."

The new Interpretive Notice will require the CTA to determine the quantity of lots or contracts for a bunched order based on the equity in each individual sub-account and not based on the overall equity of the Master Account. The CTA must also inform the FDM or RFED, prior to or at the time the CTA places a bunched order, of the number of regularly offered and tradable sized lots or contracts each individual customer will receive if the order is filled based on a predetermined acceptable allocation methodology.

In addition, the Notice states that all customers should be allowed to make additions and withdrawals in a fair and timely manner that does not affect other customers who are being managed by the CTA in the same program. The Notice also reminds Members of the core principles and responsibilities applicable to the allocation of customer bunched orders.

The full text of NFA's rule submission letter to the CFTC can be found here.

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Board Actions

The following actions were taken by NFA's Board of Directors at their meeting on August 18, 2011.

The Board approved amendments to NFA's Interpretive Notice entitled "NFA Compliance Rule 2-9: FCM and IB Anti-Money Laundering Program."

The Board approved amendments to NFA Bylaws 1301 and 1302 and the Interpretive Notice entitled "Forex Transactions" to accommodate a new Forex Fee Schedule. (See separate story.)

The Board approved a new Interpretive Notice entitled "NFA Compliance Rule 2-10: The Allocation of Bunched Retail Forex Orders for Multiple Accounts." (See separate story.)

The Board approved amendments to the Interpretive Notice entitled "Compliance Rule 2-36(e): Supervision of the Use of Electronic Trading Systems." The substantive changes consist of the following:

  • Language was added to remind Members that any promotional material (including any that discusses demo accounts) they distribute or endorse regarding an electronic trading system or the service or quality of the system's services must accurately and completely discuss the platform's functions and operation.
  • Language was added to the Section on Credit and Risk Management Controls to ensure that Members have these controls with respect to their own proprietary trading. The new language requires the Member to have policies and procedures in place to monitor its own proprietary trading, including open positions and to monitor the impact those positions and any potential market movement or adjustments would have on the Member's ability to meet its capital requirement.
  • A section on System Controls was added to ensure that any electronic trading system can identify any trading patterns that indicate a system malfunction, especially if the malfunction could result in undue risk to the FDM or its customers.
  • A section entitled Reporting to NFA was added to include the requirements under Compliance Rule 2-48 with respect to daily trade reporting.
  • The individual section requirements regarding periodic reviews were combined into one section and provide more information on the report that the Member should prepare and the follow up relating to any findings that should be completed.

The Board approved a new Interpretive Notice entitled "NFA Compliance Rule 2-36: Requirements for Forex Transactions" to provide additional guidance to Forex Dealer Members (FDM) with respect to their trading systems and the way they handle customer orders.

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News Briefs

NFA signs agreements with GFI Group and Bloomberg to provide regulatory services to their Swap Execution Facility
National Futures Association (NFA) and GFI Group Inc. (GFI) have entered into agreements with GFI Group Inc. and Bloomberg L.P. that paves the way for NFA to perform regulatory services for both organizations' swap execution facility (SEF). The Agreement establishes a preliminary framework for the exchange of information and the development of technology standards that will enable NFA, to develop, test and launch automated trade practice and surveillance systems and also to develop procedures and processes necessary for GFI and Bloomberg to fulfill their SEF self-regulatory obligations.  Upon the issuance of the Commodity Futures Trading Commission's (CFTC) final SEF rules, NFA anticipates that it will enter into a formal Regulatory Services Agreement with both organizations.

Under the Dodd-Frank Act and the rules and regulation promulgated thereunder, SEFs will have surveillance and other regulatory responsibilities. The CFTC has proposed to allow SEFs to contract with a registered futures association, such as NFA, or another registered entity for regulatory services. 

NFA enhances educational program for arbitrators
NFA recently introduced a new online learning program for its roster of arbitrators to help them understand their duties as an arbitration panel chairperson. The new program is the third in a series of arbitration-related online learning programs developed by NFA.

NFA arbitrators are required to demonstrate proficiency in arbitration principles and procedures at least once every three years. One way arbitrators can meet this requirement is by completing the quiz located at the conclusion of the new program and sending the test score to NFA.

NFA staff to participate in compliance symposium in New York
NFA staff members have been invited to speak at the Regulatory Compliance Association's 2011 Asset Management Thought Leadership Symposium to be held on November 10 at the Pierre Hotel in New York City. The symposium's sessions include "Compliance Process, Practice & Oversight, Regulatory Priorities in 2012" and "The New 'Risk Focused' Examination Model - Latest Inquiries from SEC and NFA". More information on the symposium can be found here.

NFA to participate in two upcoming investor education conferences
NFA will be participating in two investor education conferences in November.

First, NFA staff will be at the 27th Investor Conference sponsored by the American Association of Individual Investors (AAII) on November 10-12. In addition to giving a presentation titled "Diversifying Your Portfolio with Managed Futures and Forex: What Investors Need to Know", NFA will sponsor an information booth where staff members will distribute educational materials and answer questions.

More than 1,200 individuals have registered to attend the conference, which is being held at the conference center of the Cosmopolitan Hotel in Las Vegas. For more information, visit AAII's website.

NFA will also sponsor an information booth at the Traders Expo being held at Bally's Conference Center in Las Vegas on November 16-19. NFA staff will distribute copies of NFA's investor education materials and answer questions from expo attendees.

The Expo offers educational seminars and workshops as well as an exhibit hall featuring futures commission merchants, retail foreign exchange dealers, trading software providers, futures and options exchanges and other vendors. In previous years, the Expo has attracted more than 3,000 traders. For more information visit the Expo's website.

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