CME Group lacks adequate trade monitoring procedures, CFTC says

CHICAGO Fri Aug 2, 2013 12:55pm EDT

CHICAGO Aug 2 (Reuters) - CME Group Inc should improve the way it polices its Chicago exchanges to ensure that traders are not using certain types of trades to disguise rule breaking, U.S. regulators said in a report released on Friday.

Commodity Futures Trading Commission staff said the exchange operator should make "significant and prompt" upgrades to its procedures and consider adding more staff to police markets.

The CFTC staff also expressed concerns about the low number of investigations CME launched regarding trades known as Exchange for Related Position transactions, or EFRPs.

CME staff reviewed market surveillance procedures at CME's Chicago Mercantile Exchange and Chicago Board of Trade from Nov. 1, 2010 to Oct. 31, 2011. During that period CME opened only 16 EFRP cases when nearly half a million transactions took place, according to CFTC.

Traders use EFRP to exchange an over-the-counter swap or a cash position into an equivalent futures contract. The exchange takes place away from the public marketplace and is reported to CME or CBOT once complete. Regulators want to make sure traders do not use the transactions to hide otherwise prohibited behavior.

"The one thing that really did jump out at me is the focus on EFRPs and the verbal spanking that CFTC delivered on that issue," said Craig Pirrong, a finance professor at the University of Houston.

CFTC and other regulators have been stepping up their market policing recently. In early 2012 the CFTC fined Morgan Stanley $5 million for misusing EFRPs at the CME and CBOT, causing fictitious trades in futures tied to interest rates from 2008 to 2009.

CME needs to "ensure that the factors and procedures it uses to identify EFRPs that warrant the opening of case files are adequately targeting problematic EFRPs," CFTC said. The commission said it provided specific guidance to CME relating to the establishment of an adequate program.

CME, in a statement, said it was committed to ensuring fair, well-regulated markets and had already implemented many of CFTC's recommendations.

CME should continue to monitor trading volume levels and new product launches to determine whether it needs to add staff members "to fulfill the exchanges' self-regulatory responsibilities related to market surveillance," according to CFTC.

"Adequate staffing of compliance responsibilities at the four CME Group exchanges is of particular concern because of the substantial share of the entire U.S. futures and options marketplace accounted for by the CME Group exchanges," CFTC said.

During the review period and following a previous CFTC review in 2010, CME increased its market surveillance staff to 45 people, 25 of whom were primarily dedicated to CME and CBOT, from 40 people, 22 of whom were primarily dedicated to CME and CBOT, according to CFTC.

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