NFA goes after PAMMs and money managers

Somehow this went unnoticed until James Bibbings at Turnkey Trading Partners picked it up – NFA’s Interpretative Notice to NFA Compliance

Somehow this went unnoticed until James Bibbings at Turnkey Trading Partners picked it up – NFA’s Interpretative Notice to NFA Compliance Rule 2-10 specifically targets PAMMs (Percentage Allocation Management Modules) which are quite popular with some money managers.

While PAMMs (under this specific acronym) are rare in the US there are many similar, if not identical, solutions offered by most retail forex brokers allowing money managers to control funds/accounts of multiple traders by either pooling them together or allowing to place simultaneous orders.

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NFA is worried that sub-accounts traded under PAMM, MAM or other money management tools and models are actually Commodity Pools and hence fall under the CPO regulatory requirements. NFA proposes that money managers (CTAs) looking to avoid falling under the CPO definition must treat sub-accounts as individual accounts and adhere to certain standards such as placing orders based on each sub-account’s margin equity rather than master account’s equity as well as allow quick deposit and withdrawal in a ‘timely manner’ as sometimes customer funds are locked for indefinite periods due to being locked in a collective position.

While this does make sense to the NFA this may be the end of percentage allocation models in the forex market as adapting to the required standards may be impossible for most money managers. In turn it would require brokers offering these modules to change the way their money management solutions technically operate. It remains to be seen whether this notice would be accepted (it surely will), when and how it’ll affect the forex money management market which until now was a key growth driver for US forex brokers, especially ever since the IBs were put under severe limitations.

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NFA adopted this Interpretive Notice to Compliance Rule 2-10 to address concerns involving an allocation procedure – known as Percentage Allocation Management Module (PAMM) – that is being used by CTAs that manage retail forex customer accounts when allocating bunched orders placed by them on behalf of multiple clients. CTAs that utilize PAMM place orders at FCMs and RFEDs for an unlimited number of customer accounts under one master account at each FCM or RFED, with each individual customer maintaining a sub-account under the master account. CTAs utilize the total equity of the master account to place a bunched order and then subsequently allocate lots based on each customer’s account equity as a percentage of the overall equity in the master account, often resulting in allocations to individual customers that are not equivalent to a regularly offered and tradable sized lot or contract.

As described below, PAMM does not treat each sub-account as an individual account, does not appear to comply with the CFTC’s interpretation of Regulation 1.35 and often does not result in the fair and equitable treatment of customer accounts. Specifically:

  • CTA’s place orders for regularly offered and tradable sized lots or contracts based on the master account’s equity and not the margin equity of each individual account. After the FCM or RFED executes the order, PAMM’s application in most cases does not result in regularly offered and tradable sized lots or contracts being allocated to individual sub-accounts. Rather, some fraction of a regularly offered and tradable sized lot or contract is allocated to each customer based upon their percentage of equity in the master account.
  • Since trades are placed in quantities based upon the master account’s total equity rather than in quantities that would be permitted based on the margin equity in each individual account, the customer accounts are treated similarly to a commodity pool’s participant units, without the master account being legally structured as a commodity pool.
  • Because FCMs and RFEDs generally will only act as a counterparty with respect to regularly offered and tradable sized lots or contracts at the master account level, PAMM often restricts the ability of account managers to offset an individual customer’s open fractional position that is not a regularly offered and tradable sized lot or contract without affecting the positions of all the sub-accounts underlying the master account. 
  • Most FCMs and RFEDs that utilize PAMM impose varying restrictions on customers withdrawing and adding funds to their accounts. In the extreme situation, individual customer withdrawal requests are held up indefinitely because the customer’s percentage share of a lot or contract may not be offset until the regularly offered and tradable sized lot or contract is offset for all customers at the master account level. In another situation, if an individual customer is removed from the PAMM methodology without their open fractional share of the lot or contract being offset, that customer’s sub-account may not incur the associated profit or loss when the regularly offered and tradable sized lot or contract is offset. Rather, the customer’s percentage share of the lot or contract is simply reallocated to the remaining sub-accounts, which immediately increases the percentage of equity each other individual account has in the total lot position. These restrictions inhibit a customer’s ability to close their account and have timely access to their funds and do not treat customers fairly with regard to trade allocations.

The proposed Interpretive Notice addresses these issues by clarifying that in order to be in Compliance with CFTC Regulation 1.35 and avoid treating individual customer accounts in a manner similar to a commodity pool participant unit, the CTA must determine the quantity of lots or contracts for a bunched order based on the equity in each individual sub-account and not based on the overall equity of the master account. The CTA must also inform the FDM or RFED, prior to or at the time the CTA places a bunched order, of the number of regularly offered and tradable sized lots or contracts each individual customer will receive if the order is filled based on a predetermined acceptable allocation methodology. Further, all customers should be allowed to make additions and withdrawals in a fair and timely manner that does not affect other customers who are being managed by the CTA in the same program. 

Finally, the Interpretive Notice reminds Members of the core principles and responsibilities applicable to the allocation of customer bunched orders. 

NFA’s CPO/CTA Advisory Committee reviewed the proposed Interpretive Notice and supported its adoption. NFA’s FDM Advisory Committee felt that CTAs should be permitted to use a fractional lot allocation via PAMM if the FDM was willing to act as the counterparty to that position when the customer decided to offset the position. Staff considered the Committee’s recommendation but concluded it did not alone entirely address the issues associated with PAMM because individual sub-accounts could still be treated similar to commodity pool participation units because trades were being placed in quantities based on the overall equity in the master account and not in a quantity that would be permitted by the equity in each individual customer account. Therefore, the Interpretive Notice requires that CTAs allocate Forex orders for multiple accounts using regularly offered and tradable sized lots or contracts, and requires Members to adhere to the core principles and responsibilities applicable to the allocation of customer bunched orders.

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