Series 34 Exam » Forex Regulatory Requirements » NFA Interpretive Notice Compliance Rule 2-36(e): Supervision of the use of Electronic Trading Systems

NFA Interpretive Notice Compliance Rule 2-36(e): Supervision of the use of Electronic Trading Systems

NFA Interpretive Notice Compliance Rule 2-36(e): Supervision of the use of Electronic Trading Systems

General: this part of the rule applies generally to FDMs and, inc certain instances, the APs of the FDM.  It will also apply to Members which solicit, introduce, or manage customer accounts (those parts applicable to FDMs will also apply to these members if the customer deals with a counterparty that is not a FDM).

Issues for white labelers: if the firm providing the white label product is a FDM, the member may rely on the FDM.  If the firm providing the product is not a FDM then the Member is ultimately liable.  In the former situation the Member must (i) Provide required notifications and disclosures to customers; (ii) Maintain records; and (iii) Respond to situations where it has reason to believe the white labeler is not complying with the Notice.

Focus on the following areas: the security, capacity, credit and risk-management controls, and records provided by the firm’s electronic trading systems.

Rule 2-36(e) provides:

Supervision.  Each Forex Dealer Member shall diligently supervise its employees and agents in the conduct of their forex activities for or on behalf of the Forex Dealer Member. Each Associate of a Forex Dealer Member who has supervisory duties shall diligently exercise such duties in the conduct of that Associate’s forex activities for or on behalf of the Forex Dealer Member.

Specific Items Discussed in Interpretive Notice

Security

  • Authentication & Encryption. User should be authenticated when logging on (passwords, secured, digital certificates, etc) and this information should be appropriately encrypted; firewalls should be used when and if appropriate
  • Customers should be able to tell the Member about access issues
  • Periodic testing. Annual independent internal audit or qualified outside audit; report docemented and provided to senior management; if any deficiency there should be follow up
  • Electronic trading system should be monitored by appropriate personnel; procedures in place for updating the system as needed

Capacity

  • Adopt and enforce written procedures to evaluate capacity of ETS
  • ETS should go through initial stress test; subject to periodic reviews thereafter by independent inside pary or qualified outside party; audits documented and reviewed by management
  • ETS should be tested for both capacity and performance; system should be designed to provide adequate capacity to meet estimated peak volume needs
  • Firm should also have procedures for following up on customer compliancts regarding these issues
  • Disaster recovery. Contingency plan should be in place should the system go down or abnormal volume; backup systems can include telephone
  • If operational issues, these should be relayed to the customers through the website, email, im, or through the phone
  • Firm should disclose that there may be system issues in advance and what customers can do.  This can be in the customer agreement
  • Credit and risk-management controls
  • Procedures should be in place to make sure there is not undue financial risk on the firm or the other customers from a customer trade
  • ETS should be designed to allow the firm to limit the customers trading; ETS should block order the exceed pre-set limits
  • ETS should be designed so that if stop-losses are exceeded positions will be closed out prior to a position becoming a deficit; there is a greater duty to make sure this is the case if the fdm states that the customer cannot lose more than they invest
  • If ETS does not automatically liquidate a position, the ETS should generate an aler to the customer
  • Periodic review of the system to make sure proper credit and risk management

Recordkeeping

  • Written procedures to record and maintain essential information re: customer order and account activity
  • Records should include: Date and time the order is received by the system; Price (or premium for an option) at which the order is placed; Price (or premium for an option) quoted on the trading platform when the order was placed (if the system is a trading platform); Account identification; Currency pair; Size; Buy or sell; Type of order (if not a straight market order); Date and time the order is transmitted to the trading platform (if the system is an AORS); Date and time of execution (if the system is a trading platform); Size and price (or premium) at which the order is executed; Date and time the execution information is received (if the system is an AORS); andDate and time the execution information is reported by the system.
  • Options also need: Put or call; Strike price; and Expiration date.
  • Time recorded to nearest second
  • Rollover information should include: Account identification; Currency pair; Size; Long or short; Date and time of the rollover; Price of the position after the rollover; Bid and ask prices quoted on the platform when the rollover occurred; Amount of interest credited or debited to the account, if any; Any other fees charged for the rollover.
  • ETS should be designed so that it is searchable for any one of a number of different items
  • Daily account records should include the following items: Account identification; Funds in the account (net of any commissions and fees); Open trade equity (the net profits and losses on open trades); and Account balance (funds in the account plus or minus open trade equity).  Options should also include: Long option value; Short option value; and Net option value.
  • ETS must have dynamic information on price changes, to the nearest second.
  • Daily exception reports. Those trades which fill outside the price range at the time order was entered into; these reports should be reviewed by management on a daily basis for suspicious or unjustifiable activity
  • Month end assessment fee reports – number and size of forex transactions for the month
  • Record retention. 5 years, first 2 in an accessable place

Trade Integrity

  • Written procedures to maintain integreity of the ETS
  • ETS should be designed to provide bids and officers related to current market activity
  • If firm advertises a particular spread (x pip) then the ETS should be able to handle this
  • ETS designed for minimal slippage, and only then based on market conditions
  • Price adjustments should be done pursuant to objective criteria identified in written procedures; otherwise management approval needed for an adjustment
  • APs should be prohibited from adjustinc prices for any reason once the order hits the ETS
  • If automatic rollover, the ETS should be designed to follow the procedures detailed in the written agreement

Annual Certification

  • By all FDMs
  • AP who is also a principal, filed with the NFA
  • Also members who are involved with counterparties which are not FDMs

Futures requirements:

Study Guide >>Forex Regulations >> NFA Interpretive Notice Compliance Rule 2-36(e): Supervision of the Use of Electronic Trading Systems

This entry was written by vbala, posted on June 4, 2009 at 3:24 pm, filed under Forex Regulatory Requirements. Bookmark the permalink. Follow any comments here with the RSS feed for this post. Post a comment or leave a trackback: Trackback URL.

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