EXPLANATION OF PROPOSED AMENDMENTS
Retail forex transactions occur almost exclusively on electronic trading platforms. All of NFA's active Forex Dealer Members ("FDMs") use electronic trading platforms, but the reliability of those platforms and the records they generate vary widely.
In 2002, NFA adopted an Interpretive Notice to Compliance Rule 2-9 entitled "Supervision of the Use of Automated Order-Routing Systems" ("the AORS Interpretation"). That Interpretation provides guidance to NFA Members on how they can fulfill their supervisory responsibilities over the security, capacity, and credit and risk-management controls provided by electronic systems that route orders to an exchange for execution. Therefore, it does not address retail forex systems.
Similar guidance will help FDMs comply with their supervisory responsibilities under NFA Compliance Rule 2-36(e). Certain provisions of the Interpretive Notice also apply to those Members subject to NFA Compliance Rule 2-39. In particular, those provisions apply to otherwise unregulated Members who solicit, introduce, or manage retail forex accounts. They do not apply to Members who are registered as broker-dealers and are members of NASD.
The Interpretive Notice is modeled after the AORS Interpretation, modified as necessary based on the differences between exchange-traded agency markets and off-exchange dealer markets. The interpretation also includes two new sections:
The differences in the security and capacity sections are minor. The general standard for credit and risk-management controls is the same as in the AORS Interpretation, but the discussion of account controls is not. Many FDM trading platforms automatically liquidate positions before an account goes into a deficit, and some FDMs use this as a selling point for their platforms. Therefore, the Interpretive Notice requires firms that use this function to set the automatic liquidation levels high enough so that positions will be closed out at prices that will prevent the account from going into a deficit position under all but the most extraordinary market conditions.
- The AORS Interpretation did not deal with recordkeeping requirements since CFTC rules already addressed time-stamps and other relevant system information. There are no corresponding CFTC or NFA rules for forex systems, so the notice includes a section on recordkeeping.
- The AORS Interpretation was limited to order-routing systems and did not address trading platforms. Since the notice primarily deals with dealer trading platforms, a section on trade integrity has been added.
The new section on recordkeeping spells out the information the system must record and maintain. As a general standard, it states that Members who handle retail forex orders must adopt and enforce written procedures reasonably designed to record and maintain essential information regarding customer orders and account activity. It then addresses the specific information that the electronic system should record and maintain in three categories:
The new section on trade integrity sets a general standard requiring FDMs to adopt and enforce written procedures reasonably designed to ensure the integrity of trades placed on their trading platforms. It then discusses three areas of potential concern.
- Transaction records for orders (which must include the types of information contained on orders for exchange-traded commodities) and rollovers;
- Account records showing the financial status of each account; and
- Time and price records similar to those maintained by the futures exchanges.
Finally, the Interpretive Notice requires a principal of the Member to certify that the firm has met the relevant standards in the Notice. This principal must be registered as an AP to ensure that NFA has jurisdiction over the individual as well as the firm if the certification is false.
- Pricing. The Notice states that trading platforms must be designed to provide bids and offers that are reasonably related to current market prices and conditions.
- Slippage. The Notice states that an electronic trading platform should be designed to ensure that any slippage is based on real market conditions. Furthermore, if an FDM advertises "no slippage," the platform should be designed to execute a market order at the price displayed when the order is entered and to execute a stop order at the stop price.1
- Rollovers. The Notice provides that the platform should be designed to ensure that automatic rollovers comply with the terms disclosed in the customer agreement.
Some forex systems either already comply with these requirements or should need only minor modifications. Other systems may need major upgrades, however NFA will provide a significant lead-time between the CFTC's approval and the effective date of the Interpretive Notice.
1 The Board also amended the Interpretive Notice on Forex Transactions to clarify when an FDM can advertise "no slippage" without it being misleading. That amendment is included in a separate submission letter.