SD Members: Educational resources, common deficiencies and other important regulatory information

On an ongoing basis, each NFA Member is required to update its Member Questionnaire in the event of a material change to its operations. For example, if a Member begins doing business or a pool commences operations, the Member must immediately update its Member Questionnaire. Every firm should carefully review the Member Questionnaire to ensure it accurately reflects current business operations. This will ensure that NFA's BASIC system displays correct information about the firm's business activities and that the firm receives all applicable notices relating to its reporting requirements in a timely manner. Members should also review the Member Questionnaire templates, which include all possible and available questions in the filing.

SD Members are required to make and keep records of all their swaps activity, including daily trading records for all swaps executed—as well as other transaction, position and business records—pursuant to CFTC Regulation 23.201 and CFTC Regulation 23.202. SD Members should ensure required records are both complete and accurate.

SD Members are required to have a supervisory program to diligently supervise all activities relating to their business pursuant to CFTC Regulation 23.602 and NFA Compliance Rule 2-9 and must implement policies and procedures designed to prevent fraud, manipulation and other abusive practices prohibited by CFTC Regulations 23.402 and 23.410. Additionally, SD Members are required to communicate with counterparties in a fair and balanced manner as detailed in CFTC Regulation 23.433. Common deficiencies in this area include:

• Failure to conduct adequate trade surveillance to detect fraud, manipulation and abusive practices. All products traded and associated persons should be considered in determining the appropriate scope and frequency of reviews.  Based on the nature of the firm's business, relevant risks should be considered in developing surveillance procedures.
• Failure to reasonably tailor communication surveillance procedures based on approved communication methods, including the prevalence of communication in foreign languages, to ensure fair and balanced communications and the prohibition of fraud, manipulation and other abusive practices. 
• Failure to identify and remediate system outages in a timely manner.

SD Members using NFA-approved risk-based models to calculate initial margin (IM) must conform to model requirements pursuant to NFA Compliance Rule 2-49 and requirements detailed in the IM Model Approval Letter and the IM Model Oversight Program. As part of these requirements, each SD must monitor its model performance by employing, at a minimum, all of the tests required by NFA Compliance Rule 2-49. Test results must be assessed with clearly established and justified thresholds for acceptable model performance and procedures specifying how identified performance issues are addressed for each type of testing.

SD Members must re-validate the IM model on a periodic basis (at least annually), and the Model Risk Management (MRM) function must opine on each new semi-annual version of the IM Model prior to its release into production. MRM's review should, at a minimum, be commensurate with the scope of the IM model changes. The pricing and feeder models to the IM model must be subject to established model governance policies and procedures and be subject to re-validations or other validation activities on a periodic basis.

The reviews required by internal audit under CFTC Regulation 23.154(b)(5)(iv) must assess the effectiveness of the controls supporting the IM model measurement systems, including the activities of the business trading units and risk control unit, compliance with policies and procedures and calculation of the covered swap entity's IM requirements.  To ensure that reviews are effective, firms should consider testing procedures that challenge the results of key activities, such as model performance monitoring practices, and determine the frequency and scope of such testing procedures that are reasonably based on the firm's circumstances.

Finally, SD Members must notify the CFTC and NFA of certain events related to an NFA-approved IM model. Common deficiencies in this area include:

• Failure to adequately monitor model performance and report material model performance issues in a timely manner.
• Failure to have adequate documentation supporting monitoring activities.
• Failure to notify NFA upon the remediation of the previously reported model performance issue.

When NFA-approved internal models are used to determine regulatory capital or minimum capital requirements, SDs must conform to NFA requirements detailed in the Capital Model Approval Letters and internal model oversight processes. As part of these requirements, each SD must conduct periodic independent model validation and ongoing performance monitoring, and audit of the SD's own use of the internal models at the legal entity level. An SD Member using other models in its framework to comply with minimum capital requirements that are not required to be approved by NFA (e.g., pricing/feeder models and internal models to determine the risk margin amount), should include these models in the SD's independent model validation, ongoing performance monitoring and audit processes.

Ongoing monitoring of the model performance must include, at a minimum, all the tests required by NFA Compliance Rule 2-49, CFTC regulations and NFA's conditions for approval, as outlined in NFA's approval letter. Test results must be assessed with clearly established and justified thresholds for acceptable model performance and remediation procedures for each type of testing. Each SD's MRM function must review, assess and opine on the ongoing monitoring testing results and reports before submitting required quarterly model performance reports to NFA, as applicable. Submissions must be consistent across various regulatory filings. For example, firms have failed to report the same number of backtesting exceptions in reports submitted in accordance with CFTC Regulation 23.105(k) and other internal monitoring reports required by NFA for the same time period.

The required reviews and monitoring of models used to determine regulatory capital or capital requirements must be evidenced in writing.  SDs must also maintain adequate supporting documentation to verify the testing conducted, scope of testing procedures, and conclusions reached.