United States: Update On NFA's Swap Dealer Examinations And Upcoming Priorities

1. Introduction

Both the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA), the self-regulatory organization for the US derivatives industry, have signaled their expectation—now nearly four years after swap dealers first became provisionally registered—that firms have had sufficient time to implement fully the CFTC's swap regulations. This alert updates recent changes in NFA's approval process, provides a status report on NFA's current examination schedule and previews what changes swap dealers may expect in future NFA examinations.

Most notably, NFA is likely to begin conducting examinations of non-US swap dealers for the first time. In addition, during the course of its future examinations, NFA is likely to evaluate whether firms have taken appropriate corrective action based on prior feedback.

2. Background

In January 2012, the CFTC adopted final rules regarding the registration of swap dealers and major swap participants1 and delegated responsibility for the registration process to NFA.2 Swap dealers began filing applications for registration and became provisionally registered beginning on December 31, 2012.

As of October 2016, 104 firms are provisionally registered as swap dealers. Approximately half are located in the United States; the rest are located in jurisdictions including Australia, Canada, the European Union, Japan, Mexico, Singapore and Switzerland. NFA is currently working to complete its second cycle of swap dealer examinations and is in the process of preparing its third cycle of swap dealer examinations, to commence in 2017.

Since initiating its program, NFA's swap dealer registration approval process has undergone a number of significant changes. Moreover, there have been significant shortcomings noted in NFA's current examination cycle. Finally, NFA has unveiled its priorities relating to the CFTC's new margin rules.3

3. Changes to Section 4s Review Process

NFA evaluates each swap dealer application, together with the swap dealer's policies, procedures, and other required documentation (Section 4s Submission),to determine the firm's ability to comply with its swap dealer obligations.

After a swap dealer applicant becomes provisionally registered, NFA conducts a substantive review of the Section 4s Submission, in coordination with the CFTC. Prior to January 2016, if NFA determined there were deficiencies in the submission, it would provide the swap dealer with a Feedback Letter and require it to submit additional information and/or revised policies and procedures in response, which NFA would then review.

In January 2016, the CFTC approved modifications to NFA's Section 4sreview process permitting firms to submit an attestation to NFA instead of providing revised or additional documentation or information. Each swap dealer must now submit an attestation signed by a principal attesting that the swap dealer has updated its policies and procedures to address comments in NFA's Feedback Letter within the time frame specified in the letter. After the swap dealer provides the attestation to NFA, NFA issues an Acknowledgement Letter informing the swap dealer that NFA does not at that time have any further inquiry regarding the Section 4stopic area to which the attestation relates.4

Failure by a swap dealer to attest as to its remediation of any deficiencies noted in the Feedback Letter after the compliance date of a particular requirement has passed will result in notification by NFA that the application is deficient and must be withdrawn. That firm will no longer be provisionally registered and may not conduct any new swap dealing activity. A provisional swap dealer will become fully registered after it has received Acknowledgement Letters for each Section 4s topic area. Although swap dealers are no longer required to submit revised or additional documentation in response to Feedback Letters, NFA will review a firm's compliance with its policies and procedures as part of its regulatory oversight processes.5

4. NFA Examinations

Overview. NFA commenced a program of on-site examinations to evaluate the implementation of the swap dealer requirements and related firm policies and procedures beginning in the summer of 2014. During the first cycle of examinations, conducted between 2014 and early2015,NFA focused on the key requirements and procedures governing chief compliance officer (CCO) programs for US swap dealers. Since the CFTC has granted substituted compliance for virtually all the CCO requirements,6 non-US swap dealers relying on substituted compliance were not examined during this cycle.7

The second cycle of examinations, which commenced in 2015 and continues as of the date of this update, has focused on risk management and market practices. Similarly, since substituted compliance has been granted for swap dealer risk management requirements, this cycle has focused on US firms and has excluded non-US swap dealers relying on substituted compliance. NFA is conducting this second cycle in three rounds. It has completed the first two rounds and is well into the third, which it expects to complete by spring 2017 with the issuance of reports to the examined swap dealers.

In contrast to the first cycle, which reviewed the relatively narrow set of CCO requirements, this cycle has captured a wider range of regulatory expectations. NFA has adopted a risk-based approach to this examination cycle, focusing its attention on particular areas based on the inherent risk of specific rules and relevant market developments, informed by news events as well as NFA's observations gleaned through its Continuous Monitoring Program (CMP) discussed below.

With respect to risk management, NFA is evaluating issues, including risk governance, market risk, credit risk, business unit responsibilities and annual testing of the risk management program. Regarding market practices, examinations have focused on surveillance, fraud, manipulation and other abusive practices.

Status and Key Findings. As a general matter, based on the first two rounds of this second cycle, NFA has identified three key areas of concern: (1) recordkeeping; (2) risk management programs; and (3) risk governance.

Recordkeeping. Consistent with the CFTC's regulations, NFA expects that swap dealers will maintain full, complete and systematic records of all swaps activities, including daily trading records of all executed swaps. The examinations so far have found that several swap dealers have failed to maintain adequate records necessary to conduct a comprehensive and accurate trade reconstruction for each swap as required by Regulation 23.202. In particular, NFA has uncovered deficiencies relating to the ability to recreate pre-trade positions.

Risk Management Program. Under Regulation 23.600, each swap dealer must establish and enforce a system of risk management policies and procedures designed to monitor and manage the risks associated with its swaps activities (Risk Management Program). NFA's examinations have revealed certain shortcomings with respect to swap dealers' Risk Management Programs. For example, NFA has found that several firms have failed to conduct adequate annual testing regarding their adherence to, and the effectiveness of, their respective Risk Management Programs. NFA has also found that other firms have failed to report the results of such annual reviews to the CCO, senior management and governing body, as required by the rules.

Risk Governance. NFA has found that, although most firms generally have in place adequate processes to manage risk, there are a number of discrete structural and technical gaps relating to risk governance in some swap dealers. For example, NFA has found that because some firms have not properly established senior management and governing bodies for their swap dealers, they could not demonstrate that certain duties enumerated in the regulations were being carried out.

Among the challenges NFA is facing in its swap dealer examinations relate to its access to a firm's records. NFA is sometimes provided with documents that have been redacted on the basis that the information is privileged, not relevant to the swap dealer, proprietary or subject to supervisory information deemed confidential by a federal bank regulator (CSI). NFA has stated

that, in its view, the only reason it will consider it acceptable to redact information is CSI, and then only after the firm has sought and been refused permission from the relevant bank regulator to provide the information to NFA. With respect to documents that might be attorney- client privileged, firms should be aware that disclosure to NFA could result in the loss of the privilege. This should be weighed against the possible consequences of resisting disclosure in an examination.

A separate challenge relates to the large size and complexities of some of the swap dealers subject to NFA examination. Because NFA has been examining U.S. swap dealers on a consolidated corporate group basis (i.e., one examination per family of affiliates in the United States), the SRO has found that some of its member firms have challenges scheduling meetings with key stakeholders or providing certain requested documents without delays.

It remains to be seen whether NFA will continue to see similar deficiencies and challenges in its third round of this examination cycle and whether it will identify additional significant concerns.

Third Examination Cycle. Looking ahead to 2017, NFA is in the process of preparing its third cycle of swap dealer examinations and expects to share more details with market participants next year. Although NFA has not yet finalized the scope of its upcoming examinations, it is likely to conduct examinations of non-US swap dealers for the first time. In addition, during the course of its future examinations, NFA is likely to evaluate whether firms have taken appropriate corrective action based on prior feedback.

5. Continuous Monitoring Program

NFA introduced the CMP in the spring of 2015, with an aim to keep abreast of industry developments and areas of concern. The CMP's activities, which are separate and apart from NFA's on-site examinations, occur through a combination of periodic meetings with the swap dealer CCO and other key personnel, reviews of swap dealers' responses to NFA's annual questionnaire and other reports, and assessments of broader events or trends that could impact the swaps market more generally. The CMP's outreach has included non-US swap dealers that have elected substituted compliance, giving NFA a view into these firms even though it has not yet examined any such firms. Consistent with NFA's risk-based approach to examinations, the CMP is designed to inform NFA and focus its attention on key areas of concern. Input from the CMP has informed and is expected to continue to inform NFA's risk-based approach to its swap dealer examinations. As a result of the CMP, NFA added market practices and pre-trade recordkeeping to its risk management examination cycle.

6. Margin Rules

In January 2016, the CFTC adopted final rules establishing initial and variation margin requirements for uncleared swaps entered into by swap dealers for which the CFTC is the primary financial regulator—in general, non-bank swap dealers.8 The CFTC's margin requirements do not apply to swap dealers subject to supervision by a Prudential Regulator.9 The CFTC's margin rules permit a covered swap dealer to determine its initial margin requirements based on a standardized grid-based calculation or an internal risk-based model approved by the CFTC or NFA. The CFTC has delegated to NFA the authority to review and approve such internal risk-based initial margin models for compliance with the quantitative and qualitative standards set forth in the margin rules. In this regard, NFA has outlined a multistep evaluation process involving exploratory discussions, submission of margin model proposals, review and assessment, and, ultimately, approval.10 To the extent permitted under the applicable legal frameworks, NFA has worked to coordinate with the Prudential Regulators to ensure consistency in approach to internal model evaluation and to avoid duplicative efforts.

On an ongoing basis, NFA will actively monitor firms' margin models and overall compliance with margin regulations as part of its general examination authority. The CFTC has adopted a phased-in implementation schedule requiring swap dealers to come into compliance with the margin rules over the next four years, beginning with compliance by the largest swap dealers on September 1, 2016. All covered swap dealers (and all counterparties affected by the rules) will need to comply with the variation margin requirements beginning on March 1, 2017. The CFTC will allow substituted compliance for certain of the margin rules for jurisdictions it determines have comparable rules. On September 8, 2016, the CFTC made its first comparability determination for margin and granted substituted compliance for all of Japan's margin requirements for uncleared swaps except for requirements relating to the treatment of inter- affiliate swaps.11

Footnotes

1 Performance of Registration Functions by National Futures Association With Respect to Swap Dealers and Major Swap Participants, 77 Fed. Reg. 2708 (Jan. 19, 2012).

2 Participants, 77 Fed. Reg. 2613 (Jan. 19, 2012).

3 Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 Fed.Reg.636 (Jan. 6,2016).

4 Notice I-16-01, Revised SD and MSP4s review process (Jan. 6, 2016).

5 Notice I-16-01.

6 Substituted compliance was not granted for certification and submission to the CFTC of the CCO annual report.

7 For a more detailed discussion of recent NFA examinations of CCO programs, see Dan M. Berkovitz and Gail Bernstein,Swap Dealer Chief Compliance Officer Requirements—Recent Developments, 49 Review of Securities & Commodities Regulation, No.4, at 41 (Feb. 24, 2016).

8 Margin Requirements Adopting Release, supra n.3.

9 The Prudential Regulators, which have adopted their own final margin rules, include the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Administration and the Federal Housing Finance Agency.

10 See Notice I-16-13, NFA approval process for risk-based initial margin models for uncleared swaps for certain SDs and MSPs (Apr. 14, 2016).

11 Comparability Determination for Japan: Margin Requirements for Uncleared Swaps for Swap Dealers and Major Swap Participants, 81 Fed. Reg. 63376 (Sep. 15, 2016).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions