Reporting requirements for the National Futures Association (NFA) have only been in effect for two years and are mandatory for firms trading futures, forex, or OTC derivatives. It has taken the full two years to answer some of the questions complying firms have. The NFA has provided some guidance on their terminology and definitions but there is a long way to go. In this blog, we provide:
- Background on the NFA
- Key topics on NFA reporting requirements
- Lessons Learned: Three issues and suggestions for a smoother filing process
NFA Background: As the self-regulatory organization for the U.S. derivatives industry, membership in NFA is mandatory for any business involved with U.S. futures exchanges or the retail forex marketplace. Swap dealers (SDs) and major swap participants (MSPs) are also required to be members. Swap Dealers registered with the U.S. Commodity Futures Trading Commission (CFTC) must also be a member of the NFA.
As amended by Dodd-Frank, the Commodity Exchange Act (CEA) defines the term commodity pool (and therefore Commodity Pool Operator (CPO)) in a more encompassing way than in the past. As a result, the NFA requires quarterly filing for all funds or portfolios that have 5% in derivatives. This includes: futures, options, swaps and forex.
These exemptions are detailed in 4.13(a)(3) – de minimis rule where there is an exclusion from Commodity Pool Operator (CPO) registration for entities that engage in a de minimis amount of derivatives trading activity.
4.13(a)(3) Exemption Limitations are similar to those in the CTFC Rule 4.5:
- Aggregate initial margin, premiums and required security deposit for commodity positions cannot exceed 5% of the liquidation value of the fund’s portfolio (after taking into account unrealized profits and losses), or
- The aggregate net notional value of commodity positions will not exceed 100% of the liquidation value of the fund’s portfolio (after taking into account unrealized profits and losses).
The compliance, legal or financial reporting area of a firm may be the one responsible for determining which funds are eligible for the exemptions mentioned above. To be conservative, some firms may elect to report if there is any chance a particular fund might cross the 5% threshold.
NFA reporting requirements: Not surprisingly, the regulatory requirements for firms requires significant time and attention on the part of a participating firm. Upon first review of the NFA website, you will find pages and pages of documentation. If you aren’t the one filing for your firm though, you won’t be able to see the required questions and calculations without logging in.
The NFA website does provide some of the broad topics that they require for a filing. These include but are not limited to: capital and margin requirements, risk management (monitoring and managing), reporting and recordkeeping, daily trading records, business continuity and disaster recovery, business conduct standards, documentation standards, duties (e.g., conflicts of interest, risk management, portfolio reconciliation and compression), Chief Compliance Officer (appointment and duties), segregation of collateral, segregation of customers, funds for uncleared swaps, conflicts of interest policies and procedures, recordkeeping and reporting, swap processing and clearing: including policies and procedures, and swap documentation. With that long list of items that requires attention, you can see how much effort can be required to properly report.
Lessons Learned: Three issues and suggestions for a smoother filing process
- Keeping a record of the actual data that was reported to the NFA: Since databases are typically updated over time, it is critical to keep an extract of the actual data that was used in your reporting. A change control process and documentation of any changes to the data that was used should be implemented.
- Mapping: Your firm may have a different definition of which countries are included in a specific geographic region than the NFA or other asset management firms. Asset types may also be classified differently by one entity vs. another. Even the basic question of “what is a derivative” can be interpreted differently by various parties. Again, the key is to properly document your firm’s assumptions so you know what was included and not included in your reporting.
- There will be questions on the questionnaire that make no sense. For example, the questionnaire asks you to break down all holdings into funds- equity funds or mutual funds. What do you do if you have equity mutual funds? Where do they go? Again, the key here is to document your assumptions and keep them consistent in classification for each quarterly report.
IMP has specific experience in NFA reporting and can assist by providing a third party process for documenting and ensuring your filings are robust. We can also assist with questions a firm has in looking for gaps in the process before an NFA audit.
Stay tuned for Part II of this blog where we will cover specific NFA questions.
This outline is for informational purposes only and does not constitute legal, regulatory or investment related advice. Additional information can be found at www.nfa.futures.org and http://www.nfa.futures.org/NFA-compliance/NFA-swap-dealers-major-swap-participants/4s-rule-descriptions.HTML