Swaps: Common Exam Findings & RemindersC l i f fe A l l e n , J e a n L o u i s I I , H e at h e r N av i n & Kat i e S e q u i n

COMMON EXAM FINDINGS

CCO & Diligent Supervision

• CCO-related issues may present themselves at any time, regardless of whether NFA is specifically reviewing a firm’s CCO oversight program

• Any one material finding or a pattern of significant findings in multiple rule areas may indicate a failure to implement a reasonable CCO program or diligently supervise

CFTC Regulations 3.3, 23.602; NFA Compliance Rule 2-9(d)

CCO & Diligent Supervision: Common Exam Findings

• Too much reliance on business lines to monitor, self-identify issues and escalate to Compliance

• A pattern of issues indicating larger concern

When NFA raises diligent supervision as an issue, it tends to be very high severity.

CCO & Diligent Supervision: Better Practices

• Clear administration of policies and procedures to relevant stakeholders• Active Compliance oversight of SD business

• Compliance may place some (but certainly not all) reliance on the LOB for monitoring

• Compliance can layer in additional independent oversight and testing

• Firms may tailor monitoring to their unique business activities to target relevant risks

• Robust issues management framework to account for identification of issues, tracking, escalation and remediation

• Escalation may involve outreach to NFA

Recordkeeping

• Required Records – 23.201• Daily Trading Records – 23.202• Records, Retention and Inspection – 23.203

Recordkeeping may not be explicitly scoped into an exam however these rules are examined for compliance in each of

NFA’s reviews

Recordkeeping: Common Exam Findings

• Failure to record written and oral communications, which falls under Daily Trading Records, specifically pre-execution trading information

• Primarily the case for voice communications• Failure to accurately record Required or Daily Trading Records• Failure to provide Required or Daily Trading Records timely

• E.g., taking an unreasonable amount of time to produce records included within NFA's document requests

Recordkeeping: Better Practices

• Policies and procedures:• Creating policies and procedures to establish a foundation for good

recordkeeping practices. • Establishing resources and tools designed to ensure that records

of all required and daily records are kept, and a process exists to have them readily available upon request

• Implementing procedures to provide a step-by-step process on how to perform trade reconstruction

Portfolio Reconciliation

• CFTC Regulation 23.502 governs requirements for SD obligations to conduct portfolio reconciliations

• An area NFA has been reviewing in recent exams • Includes several components:

• Requires each SD to agree in writing to the terms of portfolio reconciliation with each of its counterparties

• Establishes frequency requirements for portfolio reconciliations • Requires each SD to establish policies and procedures to resolve discrepancies

• Establishes reporting requirement associated with discrepancies in excess of $20 million USD or equivalent

Portfolio Reconciliation: Common Exam Findings

• Firm failure to follow policies and procedures as established

• Firm identification and resolution of discrepancies resulting from portfolio reconciliations

• NFA has seen firms utilize secondary, less stringent thresholds (such as a large dollar amount, e.g., $1MM) to trigger for resolution of a discrepancy

Portfolio Reconciliation: Better Practices

• Policies and procedures that are in line with the regulation and reflective of the firm's processes in practice

• Monitoring of discrepancies • Vendor solutions• Reviews for adherence to CFTC’s requirements

Liquidity Risk

• An element of 23.600 RMP requirements • An area NFA has been reviewing in recent exams

• How an SD performs its daily measurement of liquidity needs • Should indicate how it assesses its procedures to liquidate all non-

cash collateral in a timely manner and without a significant effect on price

• Should establish the application of appropriate collateral haircuts that accurately reflect market and credit risk

Liquidity Risk: Common Exam Findings

• Policies and procedures don’t reflect the actual practices of the firm’s liquidity risk management

• Liquidity risk management policies and procedures are inadequate

• Specifically, such procedures don’t contain provisions on a step-by-step level on how firms are to liquidate non-cash collateral, resulting in firms not performing assessments of these procedures to liquidate all non-cash collateral in a timely manner

Liquidity Risk: Better Practices

• Ensuring that procedures address the daily measurement of liquidity needs

• Incorporating all swaps products traded in liquidity risk stress testing • Assessing procedures to liquidate non-cash collateral

• Implementing a contingency funding plan (CFP) which can ensure the firm has addressed potential adverse liquidity events and emergency cash flow needs

• Scenario Analyses • Stress Testing

Settlement Risk

• Another area covered by 23.600 RMP requirements• An area NFA has been reviewing in recent exams

• Firms are required to establish policies and procedures which account for:• Establishing standard settlement instructions (SSI) with each counterparty• Monitoring for incoming and outgoing settlement breaks, aging them and

resolving them

Risk of non-compliance here, especially as related to establishment and verification of SSIs can be high. Firm failures to confirm or vet wire instructions and SSIs for

outgoing payments have resulted in large monetary losses for some firms.

Settlement Risk: Common Exam Findings

• Failure to establish policies and procedures to outline process for compliance

• Failure to follow established procedures related to establishment and verification of SSIs

Settlement Risk: Better Practices

• Ensuring policies and procedures accurately reflect processes as they exist in practice

• Training

• Controls around establishing SSIs • Independent call backs • Documented four eye reviews

Market Practices & Fair Dealing (MPFD)

• Two basic components of this area are communication surveillance and trade surveillance

MPFD is an area NFA considers high risk in terms of possibility for customer harm.

Communication Surveillance: Common Exam Findings

• Failure to identify and establish relevant employees for communication monitoring

• Failure to review flagged communications in a timely manner • Failure to monitor communications of swap dealing activity in all

languages in which they are conducted

Communication Surveillance: Better Practices

• Training on fair and balanced communications • AP onboarding checks to ensure communications are retained and established for

monitoring timely • Clear processes for review and escalation of concerning communications

• Sample size for communication reviews that is reasonable given firm operations

• Lexicon list to aid in identification of concerning communications • Reviews that cover both written and verbal communications • Timely review of flagged communications

Trade Surveillance: Common Exam Findings

• Failure to establish a comprehensive trade surveillance program established to detect market abuse and monitor swap trading activity

• Too much reliance on front office review of its own activity • Firm surveillance reviews not covering all asset classes or products a

firm transacts in • Failure to review and remediate flagged alerts in a timely manner.

Trade Surveillance: Better Practices

• Training on firm standards regarding market practices and fair dealing

• Vendor solutions can assist with analysis and identification of concerning trade activity and patterns

• Clear procedures to flag and investigate concerning activity

Business Conduct Standards

• Core areas include:• General provisions• Verification of counterparty eligibility• Disclosures of material information

Onboarding: Common Exam Findings

• Failure to establish policies and procedures• Policies and procedures not reasonably designed to prevent

the firm from trading counterparties prior to complete onboarding

• Reliance on inaccurate Cross-Border Documentation, inaccurate counterparty identifications

Onboarding: Better Practices

• Robust procedures describing the implementation of Do Not Trade controls for certain counterparties or training front office staff to verify counterparty trading eligibility prior to executing a trade

• Post trade controls to identify transactions with counterparties that aren’t properly onboarded

Disclosure of Material Information: Common Exam Findings

• Incorrect classification of counterparties leading to the pre-trade mid-market mark not being delivered to counterparties prior to trading

• Incorrect reliance on counterparties protocol elections pertaining to the treatment of the delivery of pre-trade mid-market mark

• Failure to provide PTMM prior to execution of a trade

Disclosure of Material Information: Better Practices

• Proper training of front office staff to ensure they are aware of the transactional business conduct standard requirements

• Compliance testing to determine if sales and traders are meeting their requirements to provide PTMM that is performed on a consistent basis

SDR: Common Exam Findings

• There haven’t been many changes in exam findings over the last year pertaining to SDs’ swap transactional reporting requirements

• Inaccurate or incomplete reporting• Failure to report trades timely

SDR: Better Practices

• Monitoring of reporting timeframes • Daily reconciliations of reported data • Prompt correction of reporting deficiencies

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REMINDERS

Supervision of the Use of Marketing Materials

• Interpretive Notice 9077• Swap Dealer and Major Swap Participant Supervision

of the Use of Marketing Materials• Effective May 31, 2021

Supervision of the Use of Marketing Materials (cont.)

• Marketing materials• Standardized documents in the form of pitch books,

reports, letters, circulars, memoranda, presentations, publications or brochures or other standardized documents

• Delivered via either hard copy or electronically• Used to solicit a counterparty to enter into swap

transaction(s) with the SD

Supervision of the Use of Marketing Materials (cont.)

• Supervision of the use of marketing materials• Review and approval• Training• Recordkeeping

Risk-Based Scoping

• Examination is tailored to the firm• Informed by:

• Quantitative factors (e.g., swap valuation disputes, risk data filings, etc.)

• Quantitative factors (e.g., previous exam findings, remediation, material changes to business, etc.)

Document Requests

• First Day Letter request due date will be two weeks out• Trade data requests

Exception Tracker

• Exceptions communicated in writing throughout the course of the exam

• Includes a preliminary severity• Increases transparency to the SD

Exam Report

• Issued within five months of First Day Letter issuance• Exam report response shortened to 15 calendar days

QUESTIONS?

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Contact Us

If you have questions or would like more information, please contact NFA.

Cliffe Allen Jean Louis II212-346-5634 212-346-5612

callen@nfa.futures.org jlouis@nfa.futures.org

Heather Navin Katie Sequin212-513-6074 312-781-1497hnavin@nfa.futures.org ksequin@nfa.futures.org

Thank you for joining us. This session has ended.

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