On February 12, 2019, the Commodity Futures Trading Commission (CFTC) published the 2019 examination priorities for its Division of Market Oversight (DMO), Division of Swap Dealer & Intermediary Oversight (DSIO) and Division of Clearing & Risk (DCR). This marks the first time that the agency has published its divisions’ examination priorities, which serves as part of the CFTC’s efforts to advance its Project KISS initiative and demonstrates areas that the divisions view as of particular importance to self-regulation in U.S. derivatives markets for the coming year.
Division of Market Oversight
The DMO’s Compliance Branch is responsible for conducting examinations of certain types of exchanges known as designated contract markets (DCMs), along with swap execution facilities (SEFs).
To date, the DMO has only implemented an examination program for DCMs. These examinations have traditionally monitored DCMs’ compliance with the Commodity Exchange Act and other CFTC regulations through Rule Enforcement Reviews. In 2019, the DMO aims to supplement these efforts through more targeted examinations of a DCM’s self-regulatory program under clearly defined time periods, and also by focusing on emerging regulatory priorities where regulatory requirements and best practices may still be developing.
Based on these objectives and a review of the DMO’s 2018 examination program, the DMO’s examination priorities for 2019 include:
Cryptocurrency surveillance practices;
Surveillance for disruptive trading;
Trade surveillance practices (selected elements);
Block trade surveillance practices;
Market surveillance practices (selected elements);
Real-time market monitoring practices;
Practices around market maker and trading incentive programs; and
DCMs’ relationships with and services received from regulatory service providers.
The DMO anticipates that each of these examination priorities will likely be the focus of separate examinations that will address one or more DCMs. The DMO also said that it expects most registered DCMs to undergo at least one examination throughout 2019. Further, the DMO plans to conduct quarterly calls with large and medium volume DCMs and biannual calls with lower volume DCMs that will allow the DMO to stay abreast of any self-regulatory developments that occur at DCMs throughout the year.
While SEFs will not be included in the DMO’s 2019 examinations, the DMO said it will begin to establish an examination program for SEFs over the course of the year. In the meantime, the DMO will conduct regulatory consultations with a number of SEFs, which will reflect the high-level review of DCMs that took place in 2018. Such consultations will allow the DMO to provide effective oversight of SEFs while the CFTC finalizes its proposed SEF regulatory framework, and will aim to gather preliminary information with respect to a SEF’s regulatory and business operations and to educate SEFs regarding the DMO’s examination programs.
Division of Swap Dealer & Intermediary Oversight
The DSIO’s Examinations Branch oversees derivative market intermediaries, which include futures commission merchants (FCMs), swap dealers (SDs), major swap participants (MSPs), commodity pool operators, commodity trading advisors, introducing brokers and retail foreign exchange dealers.
DSIO examinations are primarily focused on the protection of customer funds. Therefore, examination resources are generally allocated towards the oversight of 65 FCMs (as they are the only registered entities permitted by regulation to hold listed derivative customers’ funds), as well as limited oversight responsibilities for approximately 100 SDs.
Throughout 2019, the DSIO will continue to conduct its standard monitoring of CFTC registrants, which includes reviewing notices, risk management programs, financial statement filings, risk exposure reports, risk assessment reports and chief compliance officer annual reports, among other things. The DSIO has also identified the following areas as examination priorities for 2019:
Withdrawal of residual interest from customer accounts;
Accepted forms of non-cash margin;
Compliance with segregation requirements;
FCM use of customer depositories;
FCM customer account documentation; and
SD/MSP relationships with third-party vendors.
Division of Clearing & Risk
The DCR is responsible for examinations of all registered derivatives clearing organizations (DCOs). However, for DCOs that have been deemed systemically important by the Financial Stability Oversight Council, the DCR performs examinations of such entities in consultation with the Board of Governors of the Federal Reserve System.
The DCR’s examinations are uniquely tailored to the risk profile and characteristics of each DCO and the products it clears, and seek to identify potential vulnerabilities at DCOs in areas that are critical to fostering a safe and efficient clearing process. These examinations are designed to assess the maturity, capabilities and overall resilience of a DCO by examining its financial resources, risk management, system safeguards and cybersecurity policies, practices and procedures.
The CFTC said it plans to publish the divisions’ examination priorities annually going forward. CFTC-regulated entities should take note of these priorities for 2019 and take steps to ensure that they are prepared for any potential forthcoming examinations.