NFA Overview Regulation Redefined Presented by Michael Braden

NFA Overview “Regulation Redefined” Presented by: Michael Braden Manager, Compliance www. nfa. futures. org

CFTC NFA Exchanges www. nfa. futures. org

NFA Membership Categories • • • Exchanges Futures Commission Merchants (FCMs) Introducing Brokers (IBs) Commodity Trading Advisors (CTAs) Commodity Pool Operators (CPOs) Retail Foreign Exchange Dealers (RFEDs) www. nfa. futures. org

Membership Breakdown by Primary Category This chart shows membership in each area as of 10/22/12 Total NFA Members: 3464

What is Forex? • Forex trading is the act of speculating in which direction the foreign currency exchange rate will move • The primary market is an interbank market where large financial institutions manage their currency exposure. As secondary market has opened up to retail investors. This is the market that NFA regulates. www. nfa. futures. org

NFA Member Forex Counterparties • • Retail Foreign Exchange Dealers (RFED): – An individual or organization that acts, or offers to act, as a counterparty to an off-exchange foreign currency transaction with a person who is not an eligible contract participant. – RFEDs are required to be members of NFA in order to conduct business with the public and are designated as Forex Dealer Members (FDMs). Futures Commission Merchants (FCM): – FCMs may also act as counterparty to retail Forex transactions. They do not need to be registered as RFEDs if they are primarily and substantially engaged in on-exchange futures activity. They must still be designated as an NFA FDM. 6

Forex Counterparty Business Models • Dealers – May have currency exposure due to uncovered customer positions – Must take haircuts on uncovered positions – Typically have desk responsible for risk management – Pricing based upon a widened aggregation of liquidity providers’ prices – i. e. mark ups • Straight -Through Processors (STP) – No inventory risk – Ensures order can be offset with a liquidity provider prior to filling customer order – Less conflicts of interest – Typically pricing is based upon marking up prices from liquidity providers and/or charging commissions 7

Historical Information on Forex Counterparties Year Number of Forex Counterparties Liability to Customers December, 2002 14 $82 million December, 2005 38 $573 million December, 2009 19 $906 million www. nfa. futures. org

Historical Information on Net Capital Requirements Year Capital Requirement for Forex Counterparties 2002 Minimum of $500, 000 2006 Minimum of $1 million for all other forex counterparties 2007 Minimum of $5 million 2008 Increase from $5 million to a minimum of $20 million www. nfa. futures. org

NFA Member Forex Counterparties • Currently, NFA has 11 members that are acting as a forex counterparty • Each firm has a net capital requirement of at least $20 million. • As of June 30, 2012, these firms has a combined customer liability of $654 million and a total of 70, 000 active retail customer accounts 65% of which are unprofitable. www. nfa. futures. org

Problems Noted: Regulatory Response • Disclosure – “Commission Free Trading” • August 2004 – Firms were required to disclose the mark-up price associated with trading. – “Customer funds are segregated” • February 2006 – Firms were required to disclose that customer funds may not be protected under bankruptcy laws. www. nfa. futures. org

Problems Noted: Regulatory Response • Financial – Security Deposits • 2002 NFA Initiative: Customers have margin requirements, similar to futures clients. 2% major pairs, 5% exotic pairs – Liability to Customers • 2007 NFA Initiative: FDMs have to maintain enough assets to cover liabilities to forex customers, which have to be held in major money market centers – Increase in Capital requirements www. nfa. futures. org

Problems Noted: Regulatory Response • Slippage – In 2009, NFA started seeing that FDMs were manipulating the prices that they were giving to customers. • NFA Response: 2009 -2011 – Fortress System – Daily reporting of all forex transactions – Slippage settings must be asymmetrical www. nfa. futures. org

Risk Based Audit System • System analyzes the risk factors associated with each firm • Risk factors that may prompt an examination – – Customer complaints Business background of principals Suspicious rates of return A highly leveraged trading program or pool

Testing at Forex Counterparties • Financial testing • Promotional and Advertising Material, and Sale Solicitations • Anti-Money Laundering Program • Systems/Trading Platform 15

Total NFA Forex-Related Disciplinary Actions • Since 2001, NFA has issued 31 Member Responsibility Actions involving Forex. These are emergency actions taken by NFA against its Members and Associates. • Since 2001, NFA has issued 129 Business Conduct Committee Complaints involving Forex. 16

Examples of NFA Forex Fraud. Related Disciplinary Actions Gain Capital Group LLC - NFA Member FDM Located in Bedminster, NJ • Unequal Slippage Tolerances: Customer would always experience unfavorable slippage when the market moved against him/her but his/her order would be rejected and requoted when the market moved in his/her favor. FX Diversified LLC - NFA Member CTA Located in Sandy, Utah • Promotional material, Registration, Solicitation 17

Examples of NFA Forex Fraud. Related Disciplinary Actions FX Bootcamp LLC – NFA Member IB Located in Peachtree City, GA • Net Capital, AML, Promotional Material violations Integrity FX LLC – NFA Member CPO Located in Riverside, CA • Misappropriation of funds 18

Up & Coming Issues • Credit Card Funding • Transparency – Fees charged to customers (i. e. mark-up on the transaction) www. nfa. futures. org

Forex Investor Resources • NFA provides the following resources to investors – BASIC – this is a tool where a customer can look up the background information on an NFA member before choosing to invest. – NFA Info Center • By phone: (800) 621 -3570 • By email: information@nfa. futures. org www. nfa. futures. org

Forex Resources Forex Investor Resources • Trading Forex: What Investors Need to Know • Forex Online Learning Program • NFA Investor Alerts Forex Member Resources • • • Forex Transactions: A Regulatory Guide Compliance Workshop for Forex IBs, CPOs and CTAs – Chicago Compliance Issues for Forex IBs, CPOs and CTAs webinar www. nfa. futures. org

Questions? Michael Braden (312) 781 -1576 mbraden@nfa. futures. org www. nfa. futures. org