Retail off exchange forex contracts can be treated
However, because the CFMA did not give the CFTC any rulemaking authority with regard to these new provisions, it was up to Congress and the courts to respond to ambiguities related to the application of the CFMA to contracts that were deemed futures look alike contracts. These contracts were often called spot transactions by the counterparties offering the contracts but instead of actually settling through delivery, as true spot contracts do, the contracts were perpetually rolled-over with each retail clients account reflecting the profits and losses from the prior contracts.
In fact, this is how much of the OTC retail forex market works and many market participants refer to the market for look alike contracts as the spot market. Following a split of authority in the courts regarding whether the CFTC had jurisdiction over futures look alike contracts, the Commodity Futures Trading Commission Reauthorization Act of CRA clarified the issue by again amending the CEA and specifically granting the CFTC authority to regulate, and create rules relating to, futures look alike contracts that are offered or entered into with retail customers on a leveraged or margined basis.
The rules impose a variety of registration, recordkeeping, reporting, and operational requirements on parties that intermediate transactions in OTC retail forex. These rules will become effective today. Regulation of CPOs and CTAs Persons that operate funds that trade forex and those that provide forex trading advice to retail clients will become subject to a regulatory scheme that essentially seeks to treat these advisers on equal footing with CPOs and CTAs that trade traditional on-exchange commodity future and option contracts.
Interestingly, the terms Commodity Pool Operator and Commodity Trading Advisor are defined separately in the regulations for the purposes of OTC forex trading, rather than being incorporated by reference. This means that OTC forex advisers will be subject to a separate regulatory regime than those that trade traditional commodity contracts, under the final rules, even if it appears to be very similar. Final Regulation 5. Those that meet this definition will be required to register as CPOs and will have to meet all the operative requirements, including the disclosure, recordkeeping, reporting, and other requirements, currently applicable to CPOs in the context of on-exchange futures and commodity option contracts.
Those that meet this definition will be required to register as CTAs and will have to meet all the operative requirements, including the disclosure, recordkeeping, reporting, and other requirements, currently applicable to CTAs in the context of on-exchange futures and commodity option contracts. These records will have to be turned over to the CFTC within 30 days of the advisers receipt of the communication, or if possible fraud is concerned, within 3 days of such receipt.
However, under the rules many firms that are currently registered as FCMs, but that are not primarily or substantially dealing in exchange-traded futures, will have to deregister as FCMs and register as RFEDs. Regulation 5. FCMs and RFEDs that fall below the net capital requirement will be forced to liquidate if they are unable to cure the deficiency within ten business days.
These new registration, risk disclosure, and net capital requirements are coupled with additional requirements relating to financial reporting and recordkeeping, trading standards, and disclosure of pending litigation, among others, to provide a framework geared toward fraud prevention and protection of retail investors as they engage in forex transactions. The CFTC notes that in the absence of such registration requirements fraudulent and deceptive sales practices have been common.
The rules require IBs that are soliciting clients for OTC retail forex transactions to either maintain the net capital requirements applicable to futures and commodity options IBs or to enter into guarantee agreements with those FCMs and RFEDs with whom they have relationships. This choice between the net capital requirement and the guarantee agreement is a change from the proposed rules which would have required guarantee agreements for all IBs soliciting retail forex accounts.
The rules further state that an IB cannot be a party to more than one guarantee agreement at any given time, effectively making IBs that cannot or choose not to maintain the minimum net capital requirements exclusive sales agents for the FCM or RFED which they represent. Regulation of Futures Look Alike Contracts The rules treat leveraged futures look alike contracts on forex essentially on par with OTC forex options and futures. Counterparties that offer look alike contracts on forex to retail clients will be required to meet the registration requirements detailed above in addition to the applicable operational, disclosure, recordkeeping, and reporting requirements.
However, the CFTC now has broad anti-fraud authority over futures look alike contracts on forex and has crafted its final rules in recognition of this new authority. Leverage Restrictions The final rules limit leverage for retail clients non-ECPs through a mechanism whereby the CFTC has set parameters and will delegate authority to the NFA to set specific limits within those parameters.
FDMs should prepare a daily computation showing the total amount of customer funds on deposit, the total amount of customer open positions, and the total amount due to customers. The firm must file with NFA three report types: daily electronic reports showing liabilities to customers and other financial and operational information; monthly operational and risk management reports; and quarterly reports that contain the most-recent performance disclosures required under CFTC Regulation 5.
The daily reports must be prepared each business day, and must be filed by noon on the following business day. The monthly reports must be filed within 17 business days after the end of each month for which the report is prepared. Similarly, the quarterly reports must be filed within 17 business days after the end of each quarter for which the report is prepared. Submitting these reports certifies that the person filing it is a supervisory employee that is, or is under the ultimate supervision of, a listed principal who is also an NFA Associate, is duly authorized to bind the FDM, and that all information in the report is true, correct, and complete.
Each FDM must have a supervisory system in place to ensure that the Risk Management Program is being diligently followed by all appropriate personnel. Written Risk Management Program Each FDM must adopt written policies and procedures that describe the risk management program and those policies and procedures must be approved in writing by the firm's governing body.
The firm must also ensure that any materials changes to the policies and procedures are approved in writing by the firm's governing body. The Risk Management Program must include procedures for the timely distribution of the written Risk Management Program to relevant supervisory personnel. The FDM is required to maintain records of the persons whom the Risk Management Program is distributed to along with the date of distribution.
The RMU must have sufficient authority; qualified personnel; and financial, operational and other resources to carry out the firm's Risk Management Program. The RMU should report directly to the firm's senior management, and must be independent from those employees involved including in a supervisory capacity in pricing, trading, sales, marketing, advertising, and solicitation activities of the FDM collectively business trading unit.
The RMU also must provide to FDM senior management and its governing body quarterly written risk exposure reports, which set forth all applicable risk exposures of the FDM, breaches of any established risk limits, any recommended or completed changes to the Risk Management Program, the recommended time frame for implementing recommended changes; and the status of any incomplete implementation of previously recommended changes to the Risk Management Program.
An FDM must also immediately provide senior management and its governing body with an interim risk exposure report any time the FDM detects a material change in its risk exposure. Elements of the Risk Management Program and Tolerance Limits The Risk Management Program must include policies and procedures to monitor and manage the following risks: market risk, credit risk, liquidity risk, foreign currency risk, legal risk, operational risk, counterparty risk, liabilities to retail forex customers risk, technological risk, capital risk, and any other applicable risk.
The Risk Management Program must set risk tolerance limits for each of these risks. The Risk Management Program must discuss the underlying methodology used in setting these limits; as well as any policies and procedures governing exceptions to these limits and detecting and reporting breaches to appropriate management. Each FDM's senior management on a quarterly basis and governing body on an annual basis should review and approve the risk tolerance limits.
Stress Testing The FDM's RMU must require the FDM to conduct stress tests under extreme but plausible conditions of all positions in the proprietary account and in each counterparty account both retail customers and ECPs at least on a semi-monthly basis. The review and testing should be conducted by qualified internal audit staff that are independent of the business trading unit, or by a qualified third party audit service, which reports to FDM staff that are independent of the business trading unit.
The review must include an analysis of adherence to, and the effectiveness of, the risk management policies and procedures, and any recommendations for modifications to the Risk Management Program. The results of the review must be reported to and reviewed by the FDM's senior management and governing body.
The FDM must document all internal and external reviews, and testing of the Risk Management Program including the date of the review or test; the results; any identified deficiencies; the corrective action taken; and the date the corrective action was taken. Recordkeeping The FDM must maintain copies of all written policies and procedures, changes to the policies and procedures and all required approvals for the period required by CFTC Regulation 1. The FDM must clearly notate any financial information that has been amended.
A firm's procedures must cover these key areas: internal policies, procedures and controls reasonably designed to achieve compliance with the BSA and implementing regulations; appointment of a designated compliance officer to oversee the program's day-to-day operations; an ongoing training program; appropriate risk-based procedures for conducting ongoing customer due diligence including, but not limited to: understanding the nature and purpose of developing a customer risk profile; and conducting ongoing monitoring to detect and report suspicious transactions and on a risk basis to maintain and update customer information including identifying and verifying beneficial owners.
Customer Identification Program The AML program must include procedures to obtain information about the customer and to verify their identity. Unlike NFA's "know your customer" requirements, these requirements apply to all customers, not just individuals. A Member must obtain the following minimum information before it transacts business e.
In addition to obtaining this minimum information, the Member must take steps to verify the customer's identity. You do not have to verify the customer's identity before transacting business with the customer but must do so within a reasonable time before or after the first business transaction. The procedures for verifying the customer's identity should: describe those situations where documents will be used to verify identity and list the documents that will be used e.
If a Member cannot identify a customer that is not an individual using its normal procedures, the Member may need to obtain information about the individual with authority or control over the account. Your firm's customer identification procedures should describe those situations where the firm will obtain this information. Members are not required to determine whether a document used to verify identity is valid. If a document appears to be a forgery or there is other evidence of fraud, however, your firm must decide whether it has enough information to form a reasonable belief that it knows the customer's true identity.
The same is true if the information provided by the customer is inconsistent e. A Member may rely on another U. The law provides a safe harbor if the BSA requires the other financial institution to have an AML program, that financial institution enters into a contract with the Member agreeing to annually certify that it has implemented an AML program and will perform the required steps, and reliance is reasonable under the circumstances.
Your firm's procedures must describe any circumstances where it will rely on another financial institution. Although the safe harbor does not apply unless all of the above conditions are satisfied, firms may also choose to rely on U. Your firm should conduct a risk-based analysis before relying on those institutions. Identifying and Verifying Beneficial Owners A Member's AML program must include written procedures that are reasonably designed to identify and verify beneficial owners of legal entity customers for which a new account is opened.
Although the number of beneficial owners for each legal entity customer may vary, each FCM and IB is required to identify at least one beneficial owner under the control prong test. Ongoing Customer Due Diligence CDD and Detecting and Reporting Suspicious Activity A Member's AML program must also include systems and procedures designed to detect and report suspicious activity, such as transactions that do not appear to have a business or other lawful purpose, that are unusual for the customer, or that cannot be reasonably explained.
Your firm and appropriate personnel should know the nature of the customer's business and the customer's purpose in entering into the transactions. Your firm should also provide employees with examples of activities that raise red flags. Each firm's AML program must require employees to promptly notify specified firm personnel of potentially suspicious activity.
Members must develop risk-based ongoing CDD procedures that are designed to: understand the nature and purpose of customer relationships for the purposes of developing a customer risk profile; and conducting ongoing monitoring to detect and report suspicious transactions and on a risk basis to maintain and update customer information including identifying and verifying beneficial owners. Members are not expected to update customer information on a continuous basis, rather Members should update customer information when they detect information relevant to assessing the risk of a customer relationship during the course of their normal monitoring.
Hiring Qualified Staff A Member's procedures should describe its policies for ensuring that employees in areas susceptible to money laundering or terrorist financing are properly qualified and trained. Your firm should perform background checks on key employees to screen those employees for criminal and disciplinary histories. Recordkeeping The procedures must also describe the firm's recordkeeping policies regarding information and documents obtained during the identification process.
Members must keep records of all identifying information obtained from customers, including a copy or detailed description of each document viewed and a description and the results of each non-documentary method used.
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