NFA Proposes to Amend Rules Regarding Risk Management Program for Forex Dealer Members
Commentary by Bob Zwirb
The NFA filed a proposal with the CFTC to amend NFA Compliance Rule 2-36. The amendments involve forex transactions and financial requirements, and would create a risk management program for forex dealer members.
Specifically, the amendments to Compliance Rule 2-36 would require each forex dealer member ("FDM") to designate a principal to serve as chief compliance officer ("CCO"). Each CCO would be required to prepare annual reports to be distributed to the NFA and the FDM's board of directors or senior officer.
Additionally, the amendments direct FDMs to establish risk management programs that 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 and
- capital risk.
The risk management program also requires firms to set risk tolerance limits for each of these risks. The risk tolerance limits must be reviewed and approved quarterly by the firms' senior management and annually by the firms' governing body. The program also requires FDMs to conduct stress tests under "extreme but plausible" conditions for all positions in the proprietary account and in each counterparty account on a semi-monthly basis.
See: NFA Rule Proposal.
Commentary
The proposed amendments, which supplement and enhance the existing comprehensive regulatory framework for FDMs by the NFA and the CFTC, are in response to events that occurred in the forex market in January, when the Swiss National Bank unexpectedly abandoned its cap on the Swiss franc's exchange rate against the Euro, which led to large losses for retail forex customers and their FDMs. The amendments, which are intended to minimize similar losses in the future, include increased capital requirements for FDMs that do business with eligible contract participant ("ECP") counterparties, and a prohibition on FDMs from acting as counterparties to dealers that do not collect and maintain the same security deposits from their customers and ECP counterparties as are required to be collected and maintained by FDMs. Given last winter's turmoil in the market, which resulted in some firms sinking underwater with respect to their capital requirements, enhanced capital and margin requirements are to be expected. The issue, however, is whether these proposals are truly aligned with the risks involved in such transactions - particularly the proposal for requiring more capital for FDMs that act as counterparties to ECP dealers.