Swaps: Common Exam Findings & Reminders - Cliffe Allen, Jean Louis II, Heather Navin & Katie Sequin - National ...

Swaps: Common Exam
Findings & Reminders
C l i f fe A l l e n , J e a n L o u i s I I , H e a t h e r N a v i n & K a t 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 II
212-346-5634                               212-346-5612
callen@nfa.futures.org                     jlouis@nfa.futures.org

Heather Navin                              Katie Sequin
212-513-6074                               312-781-1497
hnavin@nfa.futures.org                     ksequin@nfa.futures.org

Thank you for joining
     us. This session has
     ended.

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