Proposed Rule
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INTERPRETIVE NOTICES
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COMPLIANCE RULE 2-36(e): SUPERVISION OF THE USE OF ELECTRONIC TRADING SYSTEMS
Although the Board of Directors firmly believes that supervisory standards do not change with the medium used, technology may affect how those standards are applied. The forex markets are highly automated, with virtually all trading done on electronic platforms. Most orders are also placed electronically, usually entered directly with the platform via the Internet. Therefore, in order to fulfill their supervisory responsibilities, Members must adopt and enforce written procedures to address the security, capacity, credit and risk-management controls, and records provided by the firm's electronic trading systems.3 This includes electronic trading platforms, order-routing systems incorporated into electronic trading platforms, and separate order-routing systems (AORSs).4 For an electronic trading platform, the procedures must also address the integrity of the trades placed on it.
Recordkeeping
Time and Price Records. Electronic trading platforms should create daily logs showing each price change on the platform, the time of the change to the nearest second, and the trading volume at that time and price.
Exception Reports. Electronic trading platforms should generate daily exception reports showing all price adjustments and all orders filled outside the price range displayed by the system when when the order was placed.16 Management should review these reports for suspicious or unjustifiable activity.
Assessment Fee Reports. Electronic trading platforms should generate month-end assessment fee reports for each FDM using the platform. The report should summarize the number of forex transactions executed during the month and the size of those transactions.17
Retention. Members must maintain this information for five years from the date created, and it must be readily accessible during the first two years. These records must be open to inspection by NFA, and copies must be provided to NFA upon request.
Trade Integrity
General Standard. FDMs must adopt and enforce written procedures reasonably designed to ensure the integrity of trades placed on their trading platforms.
Pricing. Trading platforms must be designed to provide bids and offers that are reasonably related to current market prices and conditions. For example, bids and offers should increase as prices increase, and spreads should remain relatively constant unless the market is volatile.18 Furthermore, if an FDM advertises a particular spread (e.g., 1 pip) for certain currency pairs or provides for a particular spread in its customer agreement, the system should be designed to provide that spread.1619
Slippage. An electronic trading platform should be designed to ensure that any slippage is based on real market conditions. For example, slippage should be less frequent in stable currencies than in volatile ones, and prices should move in customers' favor as often as they move against it.
The firm's written procedures should require management approval for all adjustments to customer fill prices except those made according to objective criteria identified in the procedures. Firm personnel should document the reason for all price adjustments (regardless of whether they require management approval).20
If a Forex Dealer Member advertises "no slippage," the electronic trading 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.1721 The FDM's procedures should also prohibit personnel from adjusting prices for any reason once the order reaches the platform.1822
1 Compliance Rule 2-39 and this Interpretive Notice apply to all Members except those who are described in Bylaw 306(b). It does not apply to Members who are registered as broker-dealers and members of NASD.
2 For purposes of this Notice, the term "Forex Dealer Member" has the same meaning as in Bylaw 306, the term "forex" has the same meaning as in Bylaw 1507(b), and the term "customer" has the same meaning as in Compliance Rule 2-36(i).
3 The written procedures do not, however, have to contain technical specifications or duplicate procedures that are documented elsewhere.
4 A trading platform executes a customer's trade by assigning the other side of the trade to a counterparty. An order-routing system transmits orders to a trading platform (or to another system or individual). In most instances, the same trading system will perform both functions. NFA understands that separate systems are extremely rare in the retail off-exchange forex markets. Nonetheless, since most of the same principles apply, these separate systems are included in this Notice.
16 Obviously, this requirement does not include limit orders that are not executable when placed. The FDM should, however, have procedures for reviewing limit orders that are executed at prices inconsistent with their terms.
17 The report should exclude transactions by eligible contract participants as that term is defined in Section 1a(12) of the CEA.
18 Management should approve each fill outside the price range displayed by the system when a market order was placed and should document the reason for the fill price.
20 An unreasonable price adjustment violates NFA Compliance Rule 2-36(c).
1619 If the FDM's customer agreement provides for exceptions in volatile or illiquid markets and those exceptions are prominently disclosed, the system may be programmed to be consistent with the agreement's terms.1721 The FDM is not required to give the customer a price that is no longer reflected on the platform at the time the order reaches it. The FDM is not responsible for order transmission delays outside its control.1822 Members may not, of course, advertise "no slippage" if these conditions are not met. (See NFA Interpretive Notice entitled "Forex Transactions," NFA Manual, paragraph 9053, for a more detailed discussion of this requirement.)