The Examinations staff performs direct oversight of self-regulation at all DCMs to help ensure market integrity, customer protection, and compliance with the CEA and Commission regulations. The cornerstone of the work is the rule enforcement reviews (RERs), which consist of detailed examinations assessing DCMs' compliance with applicable "core principles" under the CEA. Different aspects of DCMs' self-regulatory programs are reviewed, including: audit trail creation and retention; trade practice surveillance; market surveillance; disciplinary proceedings; system safeguards (e.g., information security, business continuity, physical security and environmental controls); and dispute resolution mechanisms. RER results for each DCM are documented in comprehensive public reports, including specific recommendations to remedy any deficiencies identified by Examinations staff. In the future, the Commission will be required to conduct comparable RERs of SEFs and swap data repositories, swap-market entities brought under the Commission's jurisdiction by the Dodd-Frank Act.
Examinations staff will begin to establish a program for routine examinations (RERs) of new registered entities (SEFs and swap data repositories), while continuing our focus on reviews of the DCMs. These reviews are necessary to ensure compliance with statutory and regulatory requirements, including those applicable to market continuity. The additional resources requested are based upon the assumption that there will be a total of approximately 57 registered DCMs, SEFs and swap data repositories. The Commission plans to begin conducting RERs to ensure compliance with any one of the six core principles. Large exchanges will be examined annually and smaller entities every two to three years. Currently these examinations are being conducted infrequently or not at all with respect to specific core principles. Without these examinations, RERs lose their value as a Commission tool for promoting effective self-regulation and market integrity, and ensuring compliance with the CEA and Commission regulations. The Examinations section has attempted to use its limited resources in the most efficient manner possible, and has focused its RER program on the areas of highest need and risk. In the future, however, the number of regulated entities subject to RERs is expected to increase from the current 16 DCMs to a projected 50 or more DCMs, SEFs and swap data repositories. The Commission estimates that the level of effort for examinations of large exchanges is one FTE for each review, while medium to small exchanges that about one-half of an FTE per review. General market continuity examinations take approximately one FTE for each review. In general, the Commission is staffed at just over 0.6 staff years for each registered exchange. A meaningful injection of new staff resources is vital for examinations to meet even minimum expectations for effective oversight of both futures and swaps market platforms in FY 2013 and beyond. While the Commission seeks to move towards annual examination of the major entities1 , while scheduling reviews of non-major entities less frequently, the current request of 21 FTE will provide for just under 0.6 staff years per registered entity. While reducing the overall focus on examinations, this increase will ensure that the Commission can conduct for-cause examinations and a limited number of routine examinations of exchanges as resources become available. (21 FTE; $5.145 million)
The DFA requires annual examinations of systemically important DCOs. DCOs that are determined to be systemically important under Title VIII of DFA must comply with heightened risk management and prudential standards concerning payment, clearing, and settlement supervision. The mandatory annual examinations of systemically important DCOs must review the entities’ adherence to these heightened standards. Title VIII also requires ongoing consultation between the CFTC, the SEC, and the Board of Governors of the Federal Reserve System, including the scope and methodology of planning examinations of systemically important entities. The Commission currently anticipates no more than four entities will be determined to be systemically important.
The Commission currently has 14 staff on board to conduct examinations of DCOs. On average, an examination requires a team of eight FTE dedicated for six months. Examinations of larger entities, particularly those determined to be systemically important, will require 12 to 16 FTE and up to a year to complete.
While the Commission ultimately will seek resources to perform annual reviews of all major DCOs, the Commission is currently seeking an increase of 24 FTE to support annual examinations of the four systemically important entities. Including the 14 staff on-board, the Commission will be able to provide 10 FTE per review team, for a 12 month period. As the Commission gains experience with the Dodd-Frank requirements, additional resources may be required or resources could be deployed to support reviews of other clearing organizations. (24 FTE, $5.880 million)
Currently, the Commission has no staff devoted to the examinations and financial statement reviews of major swap participants and swap dealers. The Commission requests an increase of 15 FTE to support this requirement. The additional FTE resources would allow the Commission to initiate a program for the oversight of swap dealers and major swap participants, including:
While the bulk of the examinations of major swap participants and swap dealers will be performed by the NFA, the Commission will be required to undertake direct examinations of these entities in response to possible violations of the Commission's regulations, or as part of the oversight of the NFA's major swap participant and swap dealer surveillance program. The Commission also supports routine direct examinations of these entities as necessary for staff to obtain an understanding of the books and records, and general back-office operations. Such knowledge and familiarity of the operations of a major swap participant or swap dealer is necessary in order for staff to be properly prepared to respond in situations when these entities fail to meet its minimum financial requirements or other regulatory requirements. The Commission would focus its direct examinations that are not conducted on a for-cause basis on those entities that present the greatest potential exposure. These entities generally would be the most active and largest major swap participants and swap dealers, including the six members of the "G-14" dealers that are part of domestic banking organizations.
Approximately three-to-five staff members are required to conduct a limited scope direct examination of a large FCM or, as measured by regulatory capital and customer funds on deposit, other comparable intermediary. These examinations generally run for six months from start to report generation. Staff currently performs approximately 20 direct examinations each year. An increase of 15 FTE would allow the Commission to conduct limited scope direct examinations of selected swap dealers or major swap participants annually on a for-cause and routine basis, while also performing the other functions highlighted above.
In addition, the Commission requires two additional FTE to be allocated to the review of financial data submitted by the operators of large funds, including hedge funds. Under the Dodd-Frank Act, the operators of large funds that are subject to the jurisdiction of both the CFTC and SEC are required to file financial data with the SEC through the Financial Industry Regulatory Authority (FINRA). Operators of large funds that are only registered with the CFTC as commodity pool operators will file financial data with NFA. Both the CFTC and SEC would review the financial data for potential systemic risk issues and provide information to the Financial Stability Oversight Council. The two additional FTE would review such data to identify potential systemic risk issues. Financial and risk surveillance systems will be augmented or modified to support this monitoring (15 FTE, $4.265 million).
In addition to working with NFA on the development of NFA’s program to oversee major swap participants and swap dealers, the CFTC also will develop a program to assess NFA’s self-regulatory responsibilities with respect to major swap participants and swap dealers. The development of this program began in the first quarter of 2012 in order to ensure that the Commission is prepared to fulfill its regulatory responsibility to oversee the NFA once NFA commences its reviews.
The Commission currently has 20 FTE committed to conducting annual reviews of the financial surveillance programs of the NFA and CME. In order to conduct an annual review of the NFA’s oversight program over major swap participants and swap dealers, and to continue the current review of self-regulating organization, it is estimated that an additional 12 FTE would be necessary to fulfill the Commission’s mandate. The additional FTE reflect that NFA and CME currently oversee 123 futures commission merchants, while the Commission is anticipating approximately 200 swap-related entities to register as a result of the DFA rulemakings. In addition, hedge funds, large financial entities, large commercial entities and other major swap participants are likely to be much more sophisticated from an operational and bookkeeping perspective than many of the current futures commission merchants that have limited balance sheets and engage primarily in on-exchange futures transactions and/or off-exchange retail forex transactions. These sophisticated institutions will require additional staff for data acquisition and analysis. In addition, the staff assessing these sophisticated institutions will be supported by the integration of NFA systems and data with CFTC systems and data. Information will be presented for analysis in consolidated views so they can focus on analysis and review and spend less time correlating data from multiple sources. (12 FTE, $2.940 million)
An overarching goal of the CFTC is to leverage and connect common business processes and technologies across the organization. The integration of examination tools and data with registration, surveillance, and case management tools and data in FY 2013 will allow the Commission to more effectively and efficiently conduct examinations and initiate and manage follow-on activities. The Commission will be looking at tools that will support the pre-examination management process of managing the selection and scheduling of examination activities, as well as the management of examination activities in the field and post examination report development. ($0.740 million)
Organizationally, the Commission’s examinations-related increases will support the requirements of four program areas:
|Clearing and Risk||24.00||$5,880||$0||$5,880|
|Data and Technology||2.00||490||1,330||1,820|
|Swap Dealer and Intermediary Oversight||25.00||6,125||0||6,125|
|Clearing and Risk||31%|
|Data and Technology||10%|
|Swap Dealer and Intermediary Oversight||32%|
1 A major designated contract market or swap execution facility will be defined as the largest entities that contribute to at least 75 percent of observed volumes in the overall futures and swaps markets. (back to text)