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April 16, 2007
Effective Date of New Interpretive Notice Governing Electronic Trading Systems Used for Forex Transactions
NFA has received notice that the Commodity Futures Trading Commission has approved a new Interpretive Notice to NFA Compliance Rule 2-36(e) entitled "Supervision of the Use of Electronic Trading Systems." The Interpretive Notice, which applies only to systems used for forex trading, was approved by the Commission on March 28 and will become effective July 1, 2007.
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. NFA's existing Interpretive Notice to Compliance Rule 2-9 entitled "Supervision of the Use of Automated Order-Routing Systems" ("the AORS 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, but it does not address retail forex systems.
The Board determined that similar guidance will help FDMs comply with their supervisory responsibilities under NFA Compliance Rule 2-36(e). Parts of the Notice also apply to Members who are subject to Compliance Rule 2-39.
The new 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. It also contains two additional sections relevant to forex systems.
The section on security tracks the AORS Interpretation. The general standard states that Members who handle forex orders must adopt and enforce written procedures to protect the reliability and confidentiality of customer orders and account information, and the procedures must assign responsibility for overseeing the process to one or more individuals who understand how it works and who are capable of evaluating whether the process complies with the firm's procedures. This section goes on to discuss user authentication, encryption, firewalls, user authorization, periodic testing, and administration.
As in the AORS Interpretation, the section on capacity sets a general standard that requires Members who handle forex orders to adopt and enforce written procedures to maintain adequate personnel and facilities for the timely and efficient delivery of customer orders and reporting of executions. The general standard also requires Members who operate trading platforms to adopt and enforce written procedures to maintain adequate personnel and facilities for the timely and efficient execution of customer orders. In addition, the procedures must be designed to handle customer complaints about order delivery, execution, and reporting and to handle those complaints in a timely manner.
The third section also comes from the AORS Interpretation and requires Members who handle forex orders to adopt and enforce written procedures reasonably designed to prevent customers from entering into trades that create undue financial risks for the Member or the Member's other customers. Although this general standard is the same as in the AORS Interpretation, 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 added section on recordkeeping spells out the information the system must record and maintain. As a general standard, it states that Members who handle 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:
- 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.
- Pricing. Trading platforms must be designed to provide bids and offers that are reasonably related to current market prices and conditions.
- Slippage. Electronic trading platforms 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 platform should be designed to ensure that automatic rollovers comply with the terms disclosed in the customer agreement.
NFA's November 21, 2006 submission letter to the CFTC includes a copy of the Notice. ALL FOREX DEALER MEMBERS AND ALL MEMBERS SUBJECT TO COMPLIANCE RULE 2-39 SHOULD READ THE ENTIRE NOTICE. You can access an electronic copy of the submission letter at National Futures Association | News Center.
Questions concerning these requirements should be directed to Sharon Pendleton, Director, Compliance, at email@example.com or (312) 658-6540, or to John Brodersen, Associate Director, Compliance, at firstname.lastname@example.org or (312) 781-2226.
1 FDMs may not advertise "no slippage" unless they also meet the requirements described in the Interpretive Notice on Forex Transactions (NFA Manual, Para. 9053).