Proxy arp is needed when you are natting because the Natted IP is not physically given to some interface, the arp requests coming from the users will have to be answered by the firewall becuase the natted ip is configured on it.
Basically, when the clients send an ARP request for the Natted IP, the firewall says that "OK, I have this IP---So i will reply on its behalf"
Proxy arp is essential especially if the Natted subnet does not belong to the firewall itself. i.e. the natted ip range is not given on any interface of the firewall.
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