Mark E. Ruddy, Esq. and Elizabeth A. Cannon
August 24, 2016
NATIONAL FUTURES ASSOCIATION
NFA Updates Self-Examination Questionnaire for FCMs, FDMs, IBs, CPOs and CTAs
On August 15, 2016, the National Futures Association (“NFA”) announced updates to its Self-Examination Questionnaire. On an annual basis, NFA member futures commission merchants (“FCMs”), forex dealer members (“FDMs”), introducing brokers (“IBs”), commodity pool operators (“CPOs”), and commodity trading advisors (“CTAs”) have an obligation to review their operations using this questionnaire. The NFA’s Self-Examination Questionnaire is a helpful tool for members to use in order to satisfy the NFA’s obligations and continuing supervisory responsibilities under NFA Compliance Rules 2-9, 2-36, and 2-39.
Additionally, the NFA has included a Forex Electronic Trading Systems section in its Supplemental Questionnaire for IBs, and has included technical clarifications within the financial section of the Supplemental Questionnaire for CPOs. For a description of all recent updates, see the first page of the Self-Examination Questionnaire here. As a general reminder, the NFA updates it’s Self-Examination Questionnaire on an annual basis and as relevant rules are added or amended.
COMMODITY FUTURES TRADING COMMISSION
CFTC Staff Issues Final Report On De Minimis Exception To Swap Dealer Registration
On August 15, 2016, the U.S. Commodity Futures Trading Commission (“CFTC”) released a final report regarding the de minimis exception (“Staff De Minimis Report”) from swap dealer registration under the Commodity Exchange Act (“CEA”), as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Staff De Minimis Report supplements the preliminary report (the “Preliminary Report”) that the CFTC introduced on November 18, 2015. The Staff De Minimis Report provides any received commentary, additional data analysis, exclusions, potential alternatives, and a discussion of issues relating to the de minimis exception. The Staff De Minimis Report focused its investigation on the amount of swap dealing activity that would trigger requirements to register as a swap dealer. The de minimisexception provides that a person shall not be considered a swap dealer unless its swap dealing activity exceeds a specified aggregate gross notional amount threshold over any prior twelve-month rolling period. The de minimis threshold is currently subject to a phase-in and is set at $8 billion, but is scheduled to decrease to $3 billion by the end of 2017. Ultimately, the Staff De Minimis Report supports the notion that an appreciable impact on regulatory coverage could only be found where a very large increase or decrease in the threshold had occurred.
With respect to several comments received, the Staff De Minimis Report discusses several alternatives regarding the de minimis exemption. These alternatives include: (1) adjusting the gross notional de minimis threshold to an amount that is higher or lower than $3 billion; (2) adjusting the threshold to reflect each specific asset class; (3) applying a de minimis threshold that will take into account the number of counterparties and/or transactions of a market participant; and (4) excluding swaps traded on a swap execution facility (“SEF”), designated contract market (“DCM”) or cleared through a derivatives clearing organization (“DCO”) from an entity’s de minimis calculation.
In a statement made on August 15, 2016, CFTC Commissioner J. Christopher Giancarlo criticized the Commission for not providing more clarification to the marketplace on their plans for the de minimis threshold. The Commissioner warned that the potential drop to a $3 billion threshold has already impacted smaller players who have fewer swap counterparties with which to hedge. The Commissioner also noted that, as a result of this drop, many non-financial companies would have to curtail or terminate risk-hedging activities with their customers, limiting risk-management options for end-users and ultimately consolidating marketplace risk in only a few large swap dealers.
CFTC Announces Enhancements to Protect Customer Funds
On August 8, 2016, the CFTC announced three separate measures intended to improve the protection of customer funds.
The CFTC approved an order to exempt certain Federal Reserve Banks that maintain customer accounts for DCOs and that have been designated by the Financial Stability Oversight Council as systemically important Financial Market Utilities from liability under the CEA.
In addition, the CFTC’s Division of Clearing and Risk (“DCR”) and the Division of Swap Dealer and Intermediary Oversight (“DSIO”) issued interpretative letter,CFTC Letter No. 16-69, and no-action letter, CFTC Letter No. 16-68, addressing the use of money market funds (“MMFs”) by DCOs and FCMs, and the impact of amendments to Securities and Exchange Commission (“SEC”) Rule 2a-7.
CFTC Letter No. 16-69 reviewed Part 39 of the CFTC regulation governing activities of DCOs and comparatively analyzed these regulations in light of recent amendments to SEC Rule 2a-7 to the Investment Company Act, scheduled to take effect on October 14, 2016. Among other provisions, Rule 2a-7 now requires each MMF that is a “Prime Fund,” i.e., a non-government MMF, to reserve the right to suspend any redemption upon the occurrence of certain events that may potentially affect the ability of the MMF to redeem shares promptly. Under amended Rule 2a-7, suspension would commence for a period of up to ten days and impose liquidity fees of up to two percent of the value of the shares requested to be redeemed. Additionally, government MMFs would not be required to adopt similar redemption restrictions. It is the DCR’s view that, as a result of the amendment to Rule 2a-7, Prime Funds and certain government MMFs that may choose to adopt similar redemption restriction pose more than minimal liquidity risks. For this reason, the DCR believes it would be inconsistent with relevant provisions of Part 39 to permit a DCO to accept or hold initial margin in such MMFs, or to invest funds belonging to its clearing members, or clearing members’ customers, or the DCO in such MMFs. The DCR noted that government MMFs that do not possess authority to impose redemption restrictions would continue to be viewed as acceptable collateral and investments.
Based on the above reasoning, the DSIO announced in its no-action letter that once the amendments to Rule 2a-7 take effect on October 14, 2016, FCMs will be prohibited from investing customer funds in Prime Funds or government MMFs that elect to adopt redemption restrictions, with one exception. The DSIO will not recommended that the CFTC take enforcement action against FCMs that invest their own funds, held in segregated accounts, in MMFs that possess authority to impose redemption restrictions, provided these investments are limited to the amount of the FCM’s own funds the FCM holds in excess of the firm’s targeted residual interest.
CFTC Extends Relief for Non-US Swap Dealers from Transaction-Level Requirements
On August 4, 2016, the DSIO, DSR and Division of Market Oversight (“DMO”) extended the no-action relief from certain transaction-level requirements previously granted to certain non-US swap dealers (“SDs”), provided in CFTC Staff Letter No. 15-48. Transaction-level requirements include: (1) required clearing and swap processing; (2) mandatory trade execution; (3) swap trading relationship documentation; (4) portfolio reconciliation and compression; (5) real-time public reporting; (6) trade confirmation; (7) daily trading records; and (8) external business conduct standards.
Accordingly, non-US SDs who employ agents or personnel to conduct work within the United States, and who arrange, negotiate or execute swaps with non-US persons that are non-SDs, are exempt from the transaction-level requirements for such swaps. Additionally, relief from these requirements may also extend to a swap with another non-US SD. However, for relief to be extended in this case, the non-US SD would be required to comply with the multilateral portfolio compression and swap trading relationship requirements under CFTC Regulations 23.503 and 23.504, respectively.
Please note that relief is to expire on the earlier of September 30, 2017, or the effective date of any CFTC action addressing certain compliance issues implicated by transaction-level requirements, whichever may be earlier.
CFTC Letter No. 16-64 is available here.
FINANCIAL CRIMES ENFORCEMENT NETWORK
FinCEN Issues Final Rules Requiring Identification and Verification of the Beneficial Owners of Legal Entity Customers and Ongoing Customer Due Diligence Requirements
On August 12, 2016, the Financial Crimes Enforcement Network (“FinCEN”) issued its final rules concerning customer due diligence requirements applicable to FCM and IB Members. Accordingly, the new rules make mandatory the requirements that FCM and IB Members establish and maintain written procedures designed to identify and verify the identity of beneficial owners of legal entity customers. Additionally, the final rules amend the AML program requirements by requiring the inclusion of appropriate risk-based procedures to conduct ongoing customer due diligence. The NFA plans to implement these changes to amend NFA Compliance Rule 2-9 and its Interpretive Notice, “FCM and IB Anti-Money Laundering Program.” Accordingly, while FinCEN's final rules will not take effect until May 11, 2018, firms should consider making some adjustments to their AML programs, as implementation of the new requirements may require changes to systems and processes.
Notice I-16-17 provides an overview of FinCEN’s identification and verification requirements for beneficial owners of legal entity customers and amendments made to AML program requirements. In the overview, FinCEN provides a definition of “beneficial owner” and notes that the final rule excludes from the definition legal entity customer FCMs, IBs, CPOs, CTAs, SDs, retail foreign exchange dealers (“RFEDs”), major swap participants (“MSPs”), and pooled investment vehicles operated by these entities. For this reason, FCMs and IBs will not be required to apply the beneficial ownership requirements to new accounts opened for commodity pools advised, or operated by CPOs or CTAs. Additionally, the new beneficial ownership requirements will only apply to new accounts opened on or after May 11, 2018, by a legal entity customer.
The final rules also amend the AML program requirements to explicitly require that AML programs include appropriate risk-based procedures to conduct ongoing customer due diligence (“CDD”). Under these new requirements, FinCEN has made mandatory the adoption of procedures that facilitate an understanding of the nature and purpose of customer relationships to develop a customer risk profile, procedures to conduct ongoing monitoring to identify and report suspicious transactions, and to maintain and update customer information.
Further details and analysis are available on the Ruddy Gregory, PLLC website.
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For further information about any of the topics covered, please feel free to contact Ruddy Gregory, PLLC at www.ruddylaw.com or 202-797-0762.
