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09/07/2016

Permalink 05:14:00 pm, by Dana Comolli Email , 984 words   English (US)
Categories: Reconciliation, Futures Trading, Backoffice, CTA Operations

How the Right Technology will Simplify Your Life - part 1

Operating a CTA is not always the glamorous, flashy career that the uninitiated believe it to be.  It involves many tasks that can be tedious and error prone but must be performed flawlessly every day. Add to that, the ever-increasing regulatory burden, and you have something that can wear down the stoutest of traders.

While many, if not all of the tasks related to the operation of a CTA can be made easier and more reliable through the use of technology, there is a big difference between solutions that address procedural issues in a very specific way and ones that are flexible by design and can be configured to accommodate changes as they occur.

In the next two articles, I will discuss the primary problem areas common to every CTA and how they can be addressed in a flexible and reliable manner. In this article, I will look at back office trade issues.

Account Reconciliation

The reconciliation (trades, cash balances, and positions) of a firm’s accounts with its clearing brokers is a daily job that can be one of the most time consuming processes in a CTA’s operation. Yet it doesn’t have to be with the right technology.

The ideal system is able to automatically accept emailed statements (data files or human readable statements) and/or reach out to FTP sites to download them, unzip and/or decrypt them, extract the data while performing translations so the varied statement formats are transformed to the CTA’s standard, and finally, prepare break sheets for trades, balances, positions, and trading commissions. The system should be configurable by the user and be able to accommodate new and changed statement formats without the need for coding changes.

A system with capabilities such as these reduces the time and effort involved with reconciliation to almost none.

End of Day Trade File Production

Any CTA knows that there is no standard format that administrators and broker back offices want for the trade files that must be sent each day. Not only is the layout up for grabs, but the content, symbology and price format can vary as can the transmission method (email, FTP, sFTP …), not to mention file encryption requirements imposed by some (soon to be all) organizations. Manually producing and sending these files is a burden for any but the smallest advisor and developing (and maintaining) software for each new format is not in an advisor’s core competencies.

The best automated system integrate trading and account management as well as incorporating multiple communication modules that allow end-user specification of file layouts per destination, symbology, and price format. It automates the entire trade file production and transfer process and allow those files to automatically be sent without the need for user intervention.

Trade Capture

Trade capture can mean many things. It can mean a direct to the exchange or trading platform FIX connection, it can mean importing trades from a data file, or it can mean the data entry of fills received from a broker via email. In many CTA environments, it is a combination of two or more methods.

It’s important the system used by the CTA is able to capture the trades, convert the symbology and pricing to the CTA’s standards, and process them continuously and reliably, during all trading hours. Equally important is the ability of the system to be configured to adapt to accept additional or changed trade sources with a minimum of time an effort.

A robust and reliable automated trade capture system is the core of an institutional CTA and saves countless hours of effort and minimizes the errors associated with manual or piecemeal approaches.

Trade Allocation

Trade allocation is a term that conjures up one of two meanings: how a number of contracts is to be divided among several accounts when sizing a trade, or, how received quantity/fill price pairs are divided among the accounts that make up a trade. In either case, failure to do it fairly and consistently will land you in a heap of trouble with regulators (and maybe clients).

In the case of sizing trades, the typical method of contracts per million of trading size is pretty straight forward unless accounts within the trade are valued in different currencies, then a currency conversion to the model account currency must occur. For traders that ladder in and out of positions, a useful approach is to base the trade size on a target level of contracts per million after the trade is fully filled. This eliminates the rounding that occurs if each entry is sized in isolation.

For price allocation, many organizations have moved to APS. Unfortunately, not all markets can be APSed and not all clearing brokers APS the same way. Your software should be able to APS the trade in such a way that the approach used by each clearing broker involved in the trade is followed.

Better still, if your trade sizes can support it, use a simulated APS that apportions the actual fill prices in such a way that each account gets a mixed fill that is as close to the trade’s average price as possible.

I have covered the key areas of automation that must exist in the CTA if the firm is to be able to attract funds and maintain a low risk operation. Not only should these areas be automated, but they should be automated in a way that is flexible to ensure the processes can evolve as the needs of the CTA change. In my next article, I will focus on collecting and distributing performance information

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Dana M. Comolli is president of DMAXX (dmaxx.com), a back office software design firm for alternative investment managers. TheBooks software is designed for the trader, and is built to do price, position and order management, reconciliation, trade accounting, performance reporting, risk and data management and act as a gateway to a wide variety of execution platforms. You can reach Dana at: dana@dmaxx.com

08/02/2016

Permalink 10:43:00 am, by Dana Comolli Email , 839 words   English (US)
Categories: Futures Trading, Compliance, CTA Operations

Why Compliance is the New Black

Earlier this year, the NFA implemented rules that CTAs, CPOs and others must have in place a cyber security and compliance plan that provide a detailed outline on the firm’s daily behavior in following the rules, as well as a step-by-step disaster recovery plan.

Although the regulator isn’t calling in these plans, it will check them during an audit, and if you aren’t prepared, you’ll be in violation. Compliance has been upped largely due to Dodd-Frank rules, but also because the NFA and exchanges are under increased scrutiny by the CFTC.

That said, there are key areas of compliance across all regulators that need to be part of the game plan for a firm’s daily operations. Here are important aspects to include in your plan:

  1. Know your vendor and customer:  NFA Bylaw 1101 “prohibits NFA Members from doing business with most non-members that are required to be registered with the CFTC as an FCM, IB, CPO, or CTA.”  Basically, you must do business with your own. It’s up to the CTA to make sure clients, business associates, and brokers are all registered or exempted. The NFA requires you to be able to show not only the process your personnel takes to check out the potential vendor, and that means checking them through BASIC, you need to keep all the documentation on had to show your research.

    You can roll the dice and assume vendors are members, but that’s not good business. For example, let’s say you know three friends, traders, who pooled their money to invest in your CTA. First, you must make sure the key person is a qualified investor, but you also must make sure if they are a pool, all investors are qualified, and you must retain documentation confirming the fact.  In other words, if they are representing themselves as a pool or FCM, they must be registered with the NFA.  For more details on 1101, go to: https://www.nfa.futures.org/NFA-faqs/compliance-faqs/bylaw-1101/index.HTML

  2. Make sure from a CTA standpoint, your automated systems allocating trade orders are “equitable and fair.” This should be checked quarterly.

  3. Related to #2, make sure that all accounts within a program have substantially the same performance and that performance is what your marketing materials state for the program.  If different accounts have substantially different performance, the regulators may take the stand that you actually have more than one program.

  4. Not only must a CTA know who he’s dealing with on multiple levels, he needs to know what his vendors are doing, especially FCMs. One compliance expert says a CTA needs to be on top of not only filled orders, but the source data as well.  FCMs don’t necessarily hold the old back up files of trade audits (and if they do, some charge for it), and if an exchange comes asking for it, a CTA must be able to put his hands on records and source data that can build an audit trail or trading activity, and be able to produce it in a short amount of time.

  5. Sometimes slip-ups can happen due to changing regulations but often they happen due to bad communications between an FCM and client. For example, those who trade metals might be using exchange for physicals (EFPs), which are executed thru the FCM to get a futures equivalent position. In some cases, block trade rules come into play, meaning there are minimum lot sizes to a trade. The CTA must understand the rules when dealing with an executing brokers so he doesn’t unintentionally break any. 

    As an example,  if a CTA is doing a gold trade, but the executing broker could only get a partial fill, thus it’s not a block trade but an EFP, but the CTA doesn’t know this and if the FCM doesn’t do the paper work – and sometimes they don’t – the CTA is in trouble. Be on top of those trades; in the past, it used to just be a venal sin: one of not knowing. Today it’s a mortal sin, says one expert, stating that CTAs must follow up on trades.

  6. Allocation of expenses between the manager and funds, and between funds has been the focus many recent examinations and common issues have included charging expenses that are not fully disclosed to investors and charging one client an expense where another does not pay the same expense.  Examiners have been aggressively drilling down on expense allocations even when the amounts are minimal.

While NFA audits have not been as frequent during the past few years due to the recent influx of new members, the NFA has recently reached what they consider appropriate staffing levels and you should expect audit frequencies to return to normal.  It’s time to make sure you are dressed appropriately for the party.

________________________

Dana M. Comolli is president of DMAXX (dmaxx.com), a back office software design firm for alternative investment managers. TheBooks software is designed for the trader, and is built to do price, position and order management, reconciliation, trade accounting, performance reporting, risk and data management and act as a gateway to a wide variety of execution platforms. You can reach Dana at: dana@dmaxx.com

06/13/2016

Permalink 09:28:00 am, by Dana Comolli Email , 1160 words   English (US)
Categories: Accounting, Futures Trading, Backoffice, Marketing, Compliance, CTA Operations

The Big Question: How to select an FCM?

With the shrinking number of FCMs, it might seem a CTA has little choice, or in some cases, too many. Either way, you need to know the questions to ask, and if you’re not happy with the answers, move on.

When a commodity trading advisor first hangs out their shingle, the punch list is long and many items are of equal importance: infrastructure, back office software and compliance being the most common. But of course you’ll need a broker to execute and clear your trades. No doubt you already have the one you used while on your own, but as you grow your business, your brokerage needs will change, not only due to your trading and capital, but to satisfy your client’s needs as well. Here is a list of what CTAs, software vendors and brokers say you should discuss with prospective FCMs:

The Basics

  1. Yes, size does matter. Although you may like the idea of having a Goldman Sachs or JP Morgan as your FCM, the truth is your options might be limited by your size. Especially as the number of brokers has dropped from almost 180 in 2007 to 72 today, many of these, especially bank-owned FCMs, will be out of your league. Size may be a main issue: CTAs with less that $100 million may not get a chance with a large bank FCM. But what is also important is how valuable (active) you are as a customer. As banks have to deal with constricting balance sheet capital due to Basel III, they have off loaded customers who don’t meet their ROI needs. If you have $100 million AUM but trade only a limited number of lots a month, you won’t make the cut. This isn’t necessarily a bad thing as many CTAs have been shifted to smaller non-bank FCMs. Although a large balance sheet might be nice, so is not dealing with a bureaucracy. 

    The reverse is also true. As you grow, a smaller FCM may no longer be able to accommodate your capital and trading needs. No matter what your size, it’s always smart these days to have relationships with multiple FCMs; to wit, the cautionary tales of customers who had all their money with MF Global or PFG.

  2. Ask for a list of exchange memberships. It may seem a firm with more memberships is pricier, but if you trade globally and decide to go with a downstream broker, that firm will have to use another FCM to access those exchanges and you or your clients will be charged in the end. Also find out if the firm has a 24-hour CTA/Institutional desk. Even if you won’t normally need it, it’s nice to know it’s there in case of an emergency.

    Related to this are give up trades. Make sure your broker does or accepts them. Some brokers may be a perfect fit when you are trading as an individual, but a firm that won’t do or take give ups will complicate your growing CTA business.

  3. Does the FCM permit net margining across all accounts? This means if you bring on a client who has multiple accounts with multiple CTAs, you want the FCM to be able to ‘net’ the margin across all those accounts and not require each CTA to be margined separately. This is not only across CTAs, but also across various fund accounts, and similar to net margining at an exchange, allows better use of collateral for your customer. 

    Also, make sure the FCM isn’t “margin padding” your account, that is insisting on much higher (3x-4x) margin needs than exchanges require. Although all FCMs request more margin than is required (in the interest rate glory days this was an income stream for FCMs), it shouldn’t be exorbitant. One CTA says a large bank FCM was requiring 3-4 times margin as a way to get rid of business that didn’t have a strong ROI. This may be an extreme case, but keep an eye on what they are charging, and be diligent after setting up an account that the broker doesn’t change the rules, and if they do, find out why. Also, find out  - due to balance sheet issues for bank FCMs - if they charge for “excess funds” held at the FCM.

  4. Cap intro? In the “old” days many FCMS would make sure their asset allocation clients mingled with CTAs, but this is more rare today. Sure there are firms that have people who work to raise funds, but may only introduce them to CTAs they feel worthy. Think of FCMs like asset allocation targets: they have standards and just because you are a client doesn’t mean they will send clients your way. Some firms do have platforms (e.g., RJO’s Oasis) that allow asset allocators to review and invest in CTAs.

More Details

  1. Find out the format and how end of day allocation files are handled.  Most FCMs will request that allocation files be sent to them at the end of each day although some want them at the end of each session or even after each trade.  Many are flexible with respect to symbology and price format, but not all are.  Also, just because you provide data files of your allocations, it does not mean those are not being manually keyed into another system by the FCMs staff; you should check to be sure that the files are being handled in an automated fashion otherwise clearing errors are sure to arise.

  2. Online account viewing platforms and ability to provide trade prices (both actual fill and APS prices) at regular intervals during the day as well as at the end of the day.  Many firms don’t provide anything more than and end of day feed that summarizes all the trades done during the day. Ideally, the feed would be automatically generated and provided in the format and use the delivery method (sFTP, eMail, etc) that works best for you.

  3. Ask about which trading platforms are supported, such as Trading Technologies, CQG, TradeStation, Cunningham, etc.  Make sure your FCM supports your trading platform, as not all FCMs are equipped to handle all platforms.

Finally, you should always check with the National Futures Association (www.nfa.futures.org) website to see if any actions have been brought against an FCM. Also, the CFTC site carries monthly financial info on all FCMs (http://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm).  That can provide you an overview before getting into the details when interviewing the FCM.

Remember, just as you are diligent about the rest of your business, your FCM/broker partnerships are lifelines that need to be reviewed often and analyzed on a regular basis. After all, “know your customer” goes both ways in all vendor relationships.

________________________

Dana M. Comolli is president of DMAXX (dmaxx.com), a back office software design firm for alternative investment managers. TheBooks software is designed for the trader, and is built to do price, position and order management, reconciliation, trade accounting, performance reporting, risk and data management and act as a gateway to a wide variety of execution platforms. You can reach Dana at: dana@dmaxx.com

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