• CFTC and NFA have issued more than 15 enforcement orders against swap dealers in 2022.
• Five key pitfalls stand out as a common denominator: failure to report to Swap Data Repositories, failure to provide sufficient disclosures to counterparties, failure to diligently supervise trading activity, failure to maintain adequate capital reserves, and failure to maintain, preserve, and produce records of unapproved communications.

Enforcement Orders in 2022 for Swap Dealers

With the end of 2022 approaching, swap dealers can benefit from their compliance and risk managers reviewing enforcement activities of the Commodity Futures Trading Commission (CFTC) and National Futures Association (NFA). Of the many enforcement orders against swap dealers this year, the CFTC and NFA charged penalties ranging from:

• Up to $6 million for swaps reporting, supervision, and capital maintenance failures; and
• Up to $100 million for off-platform communications failures.

Five key pitfalls were common denominators among the enforcement actions.

Failure to Report to Swap Data Repositories

Swaps reporting to Swap Data Repositories (SDR) is one of the most notable features of the Dodd-Frank Act—signed into law in part to increase transparency of derivatives markets. All swaps—cleared and uncleared—must be reported to a registered SDR in an accurate and timely manner (see Parts 43 and 45 of the Code of Federal Regulations). These requirements have posed consistent difficulties for swap dealers since their enactment.

New SDR reporting rules from 2020 have helped to simplify the reporting requirements, and the latest CFTC modifications to the reporting requirements under Parts 43 and 45 are intended to clarify the compliance functions of dealers. Swap dealers that may lack the robust policies and procedures necessary to implement and remain consistent with reporting to SDRs will struggle to avoid this pitfall, as seen from the enforcement actions this year.

The main elements of reporting to SDRs that dealers should note include reporting of valuation data, classification of counterparties (e.g., U.S. and non-U.S. persons), bunched trades, real-time reporting, and treatment of short-dated foreign exchange swaps. Following from enforcement orders of prior years, the extensive list of reporting requirements for swap dealers will continue to present difficulties for firms working to maintain compliance with the CFTC and NFA requirements.

Failure to Provide Sufficient Disclosure to Counterparties

Swap dealers are required to provide to counterparties disclosures of relevant information pertaining to each swap, including the following:

• Material risks, characteristics, incentives, and conflicts of interest;[1]
• Pricing of a swap (e.g., the daily mark, mid-market mark for uncleared swaps, and the methodology and assumptions used to prepare daily marks);[2]
• The right for any counterparty (other than a swap dealer, major swap participant, securities-based swap dealer, or major securities-based swap participant) to select the derivatives clearing organization at which the swap will be cleared and the right for any counterparty to be provided clearing (when a swap is not required to be cleared);[3] and
• Other general information.[4]

Failures to disclose such information—most notably daily mark disclosures—have been a focal point of the 2022 CFTC enforcement orders. The orders this year saw several firms charged with failing to adequately disclose daily marks. Swap dealers’ compliance teams must ensure that their policies and procedures as well as ongoing training highlight the importance of pricing disclosures to their front office.

Failure to Diligently Supervise Swaps Activity

An important role of compliance teams for swap dealers is to monitor and supervise their front office teams and related swaps activity. Swap dealers must be consistent in maintaining controls to detect and investigate instances of misconduct within their various trading desks. Supervision of trading activities will continue to be a focal point of the CFTC, and dealers will need to ensure sufficient documentation of their supervisory and investigative actions.

Failure to Maintain Adequate Capital Reserves

Capital requirements for swap dealers are extremely important to regulators to help avoid or mitigate the build-up of systemic risk. One of the enforcement orders this year was brought by NFA in response to a firm’s (technically an introducing broker’s) failure to maintain its minimum required capital. A swap dealer that repeatedly finds itself undercapitalized will likely face disciplinary actions. This is an especially sensitive area for firms transacting with cryptocurrency swaps given the large shifts in the cryptocurrency markets over the past year and the increased scrutiny from other regulators and lawmakers.

Failure to Maintain, Preserve, and Produce Records of Unapproved Communications

A rapidly changing technology space provides an abundance of various communications-related applications for people to use, often free of charge (e.g., WhatsApp, Signal, Telegram). The problem with using some of these applications comes when associated persons (e.g., employees, traders) of a swap dealer communicate on these applications when they are not approved to do so, are improperly monitored by their firms, or both. Communications—specifically regarding traders—are closely scrutinized by regulators. Firms should have robust policies and procedures governing which platforms associated persons are permitted to use as well as describing the extent to which these communications platforms are monitored and recorded.

This fall, 10 different swap dealers were guilty of failing to prohibit associated persons from communicating, both internally and externally, via unapproved communications platforms. Based on the substantial size of the fines levied by the CFTC in this area, it stands to reason that firms’ monitoring of unapproved communications will be a focus area for regulators for the foreseeable future. The rapidly changing technology environment creates difficulties for firms which must constantly update their policies and procedures to ensure an adaptable compliance business unit.

Put Patomak’s Expertise to Work

Patomak has deep experience in designing and assessing compliance programs at banks, swap dealers, broker-dealers, digital asset trading platforms, futures commission merchants and other financial firms. If you’d like to learn more about how Patomak can partner with you, contact Jill Sommers (jsommers@patomak.com), Jamila Piracci (jpiracci@patomak.com) or Sudhir Jain (sjain@patomak.com).

[1] CFR § 23.431 Disclosures of material information. https://www.ecfr.gov/current/title-17/chapter-I/part-23/subpart-H/section-23.431

[2] Id. at 1.

[3] CFR § 23.431 Clearing disclosures. https://www.ecfr.gov/current/title-17/chapter-I/part-23/subpart-H/section-23.432

[4] CFR § 23.606 General information: availability for disclosure and inspection. https://www.ecfr.gov/current/title-17/chapter-I/part-23/subpart-J/section-23.606