Monday, October 14, 2019

NFA president touts global benefits of industry self-regulation

By Lene Powell, J.D.

As Europe struggles with the projected exit of the U.K. from the European Union, National Futures Industry (NFA) President Thomas Sexton explained to an audience of market participants and regulators in Paris the advantages of the U.S. model of relying on self-regulation as a first line of defense, including insight, responsiveness, and global reach. Sexton emphasized NFA’s strong relationships with international counterparts as well as non-U.S. regulators and IOSCO and described attributes essential for successful self-regulation, including mandatory membership and government oversight.

Sexton’s remarks were prepared for delivery at the Annual Compliance and Legal Conference of the Association for Financial Markets in Europe (AFME) on October 3, 2019 in Paris, France.

NFA’s mission and operations. Noting that the self-regulatory model does not exist in many jurisdictions outside the U.S., Sexton explained that as a self-regulatory organization (SRO) closely overseen by the CFTC, NFA does not operate a market, is not a trade association, and is not a statutory regulator. Rather, NFA passes and enforces rules for its members relating to business conduct, sales practices, and financial requirements. NFA has six primary functions: registration, rulemaking, monitoring members, enforcement and disciplinary process, market regulation, and dispute resolution.

NFA’s focus has evolved over time in response to changing market realities and statutory oversight responsibilities, including taking on increased oversight in the retail forex area after passage of the Commodity Futures Modernization Act (CFMA) in 2000 and certain swaps oversight activities after the Dodd-Frank Act passed in 2010.

New focus on virtual currencies and cybersecurity. As NFA continues to respond to emerging developments, virtual currencies have recently taken on increased focus, said Sexton. Although NFA members’ activity in virtual currency products has been “modest to date,” NFA carefully monitors members’ activities in these products through specific reporting requirements. NFA has also issued an investor advisory and adopted other requirements in this area, including requiring NFA members to provide detailed additional disclosures to customers.

Sexton revealed that NFA faces particular challenges in overseeing spot virtual currencies, especially with respect to verifying ownership and control. He emphasized that if an SRO is developed to oversee virtual currencies, it needs to have essential elements of successful SROs, including mandatory membership.

Cybersecurity is another area of increased NFA scrutiny. In addition to taking steps to enhance its own cybersecurity, NFA requires member firms to conduct security and risk analysis, deploy protective measures, develop a response and recovery plan, train employees, and review their programs at least every twelve months. NFA works with member firms during examinations to make sure they understand the requirements and comply.

Benefits of self-regulation. Sexton highlighted advantages of the self-regulatory model, including bringing significant resources to bear in ensuring market integrity and investor protection. NFA has 536 employees and a budget of approximately $107 million. Due to economic, reputational, and regulatory self-interest, SROs are motivated to act responsibly, develop best practices, and monitor their markets. SROs also maintain market insight by using market professionals throughout the regulatory process and can respond much more quickly than government regulators to rapid developments in the market, said Sexton.

Given uncertainties about the future of government oversight after Brexit, it is particularly helpful that SRO oversight reaches across international boundaries. Sexton pointed out that members are located around the globe, and self-regulation is defined by contract and rulebook rather than national legislative acts. NFA also coordinates closely with global counterparts. In performing on-site examinations of non-U.S. members in numerous foreign countries, including the U.K., Canada, Australia, Sweden, Hong Kong, and Singapore, NFA offers global counterparts the opportunity to participate in examinations and join NFA on-site. NFA also offers to provide NFA's examination report and the non-U.S. member's response to the report, as well as periodic examination updates.

Essential requirements. For self-regulation to work, Sexton said SROs need the following characteristics: 
  • Mandatory membership, so that firms the most in need of self-regulation do not simply evade it;
  • Recognition by industry leaders that strong self-regulation is in the industry’s long-term best interest;
  • A board and committee structure that ensures that no one industry sector dominates;
  • Commitment by the SRO’s senior management to the ideals of self-regulation;
  • Rulemaking and enforcement authority to ensure vigorous protection of market integrity and investors;
  • Effective government oversight that covers all aspects of the SRO's regulatory activity, yet does not oppressively micromanage the SRO in every detail. 
In conclusion, Sexton said that although NFA has and must continue to evolve to meet changing regulatory challenges, its mission today is the same as it was in 1982—to protect customers, protect market integrity, and foster the public's confidence in the derivatives markets.