(Dodd-Frank Act) Futures & Derivatives Law · PDF fileThe CPO and CTA Regulatory Regimes: What...

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The CPO and CTA Regulatory Regimes: What Operators of and Advisers to Commodity Pools Should Expect in 2013B y J a m e s m . C a i n , D a p h n e G . F r y D m a n a n D r ay m o n D a . r a m i r e z *

There were a number of significant changes to the regulatory regime for commodity pool op-erators (CPOs) and commodity trading advisors (CTAs) in 2012.1 As a result of these changes, various types of collective investment vehicles that previously were not regulated by the CFTC, and their operators and advisers, became subject to the oversight of the Commodity Futures Trad-ing Commission (CFTC) as of January 1, 2013. Additional significant developments are anticipat-ed for the CPO and CTA regulatory regimes in 2013. In particular, we expect there to be further developments with respect to the following areas, each of which is discussed in more detail below:

1. Application of the CPO Regulatory Regime to Funds of Funds;

2. Continued Litigation With Respect to the CFTC’s Narrowing of the CFTC Regulation 4.5 Exclusion From CPO Status for Regis-tered Investment Companies;

3. Issuance of CFTC Regulations to Harmonize CFTC and Securities and Exchange Commis-sion (SEC) Requirements for Registered In-vestment Companies;

4. Compliance With New Reporting Require-ments;

5. Additional Relief for Certain Persons From CPO and CTA Requirements;

6. Additional Guidance With Respect to Com-pliance With CPO and CTA Requirements; and

7. Compliance With New Requirements for Swaps Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act)

BackgroundThe changes to the CPO and CTA regulatory

regimes that caused many persons and entities to fall within the CPO and CTA definitions and, therefore, the CFTC’s jurisdiction, were triggered by the following events. The CFTC afforded mar-ket participants that were affected by the changes until December 31, 2012, to either: (1) register as CPOs and/or CTAs; or (2) to claim an exemption or exclusion therefrom.

• In February 2012, the CFTC adopted finalregulations that, among other things: (1) nar-rowed an exclusion available to advisers of registered investment companies, pursuant to CFTC Regulation 4.5 by imposing com-modity interest trading thresholds on invest-ments by those registered investment compa-nies;2 and (2) rescinded an exemption from CPO registration under CFTC Regulation 4.13(a)(4) that was available to operators of private funds with only sophisticated inves-tors.3 These final regulations, which also im-pacted exemptions from CTA registration to the extent that such exemptions were based on CFTC Regulations 4.5 and 4.13(a)(4), be-came effective in April 2012.4

• InOctober 2012, theCFTC’s final rules tofurther define the term “swap,” which was added to the Commodity Exchange Act (CEA) by the Dodd-Frank Act, became effec-tive. As a result, swaps became a part of the list of commodity interests that can cause a person to be a CPO or a CTA.5

The effects of these changes are being felt by registered investment companies and private in-vestment funds, among others, which are trying to determine how best to comply with a new re-gime that remains unsettled in many respects.

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1. Application of the CPO Regulatory Regime to Funds of Funds

Pursuant to the CEA and CFTC regulations promulgated thereunder, funds that indirectly ob-tain exposure to commodity interests by invest-ing in funds that are commodity pools (Funds of Funds) are themselves commodity pools. As a re-sult, operators of Funds of Funds are CPOs and may be required to register as such, depending on their eligibility for a regulatory exemption or ex-clusion therefrom.

Previously, CPOs of Funds of Funds could look to an “Appendix A” to Part 4 of the CFTC’s regulations when determining whether they were eligible for an exemption from CPO registration available under CFTC Regulation 4.13(a)(3), which exempts from registration CPOs of commodity pools that only engage in a de minimis level of commodity interest trading. Appendix A described six scenarios prepared by the CFTC staff to assist CPOs of Funds of Funds in applying CFTC Regulation 4.13(a)(3)’s de mi-nimis thresholds.

The CFTC rescinded Appendix A without explanation as part of the final regulations that amended CPO and CTA compliance obliga-tions, which were discussed above.6 Following the adoption of these final regulations, the CFTC staff indicated that it would revise the guidance in Appendix A but that, until such guidance is is-sued, market participants could continue to rely on Appendix A.7 Further, in response to a request from the Investment Adviser Association and the Managed Funds Association, the CFTC issued a no-action letter on November 29, 2012, that permits CPOs of Funds of Funds to continue to rely on the rescinded Appendix A for purposes of CFTC Regulation 4.13(a)(3) as well as for pur-poses of revised CFTC Regulation 4.5, subject to certain conditions.8 The relief afforded by the no-action letter expires on the later of (1) June 20, 2013, and (2) the CFTC staff’s issuance of revised Funds of Funds guidance.

Operators of, and advisers to, commod-ity pools that are structured as Funds of Funds should expect the CFTC staff to issue guidance

as to the application of the de minimis trading thresholds in CFTC Regulations 4.13(a)(3) and 4.5 later this year.

2. Continued Litigation With Respect to the CFTC’s Narrowing of the CFTC Regulation 4.5 Exclusion From CPO Status for Registered Investment Companies

In April 2012, the Investment Company Insti-tute (ICI) and the U.S. Chamber of Commerce (the Chamber) filed a joint lawsuit against the CFTC alleging that the CFTC violated the Administra-tive Procedure Act (APA) in adopting the afore-mentioned amendments to CFTC Regulation 4.5 in February 2012.9 Specifically, the ICI and the Chamber alleged that: (1) the CFTC’s amend-ments to CFTC Regulation 4.5 were “arbitrary and capricious” because the CFTC failed to con-sider their necessity; and (2) the CFTC failed to perform an adequate cost-benefit analysis, as re-quired by the APA. One of the goals of the litiga-tion was to forestall having advisers to registered investment companies be required to register as CPOs, by December 31, 2012, as a result of the new de minimis thresholds contained in CFTC Regulation 4.5. However, on December 12, 2012, the U.S. District Court for the District of Colum-bia dismissed the ICI and Chamber lawsuit, find-ing that there was nothing arbitrary or capricious about the CFTC’s actions in promulgating the amendments to CFTC Regulation 4.5.10 The ICI and the Chamber subsequently filed an appeal on January 11, 2013,11 for which they requested and received expedited consideration on January 15, 2013.12 On March 8, 2013, the CFTC filed a brief with the District of Columbia Court of Appeals arguing that, among other things: (1) amended CFTC Regulation 4.5 is a reasonable response to market events and the Dodd-Frank Act; (2) the financial crisis and the Dodd-Frank Act justify the CFTC’s amendments to CFTC Regulation 4.5; (3) the District of Columbia District Court correctly dismissed the ICI’s and Chamber’s chal-lenges to the proposed harmonization rules (dis-cussed below) because they are unripe; (4) the




CFTC thoroughly considered the costs and ben-efits of amended CFTC Regulation 4.5; and (5) amended CFTC Regulation 4.5 is rational in its particulars.13 Further developments in the appeal of the lawsuit are anticipated in 2013.

3. Issuance of CFTC Regulations to Harmonize CFTC and SEC Requirements for Registered Investment Companies

In light of the fact that investment companies that are registered as such under the Investment Company Act of 1940 (1940 Act) (registered in-vestment companies) are already subject to reg-ulation by the SEC, the CFTC issued proposed harmonization rules in tandem with its final rules to amend the compliance obligations for CPOs and CTAs to pools that are registerd investment companies (Proposed Harmonization Rules).14 The Proposed Harmonization Rules are intended to reconcile CFTC regulations with SEC regula-tions, to the extent that they apply to advisers of registered investment companies. If adopted, the Proposed Harmonization Rules would facilitate compliance with CFTC disclosure, reporting and recordkeeping requirements for CPOs that are ad-visers to registered investment companies. Specifi-cally, the Proposed Harmonization Rules address, among other things, CFTC regulations pertaining to: (1) the delivery of “Disclosure Documents” (akin to prospectuses) to pool participants and the contents thereof, including performance data; (2) the cycle for updating Disclosure Documents; and (3) financial reporting to pool participants.

Although advisers to registered investment companies may have been required to register as CPOs as of December 31, 2012, such advis-ers will not be required to meet the CPO disclo-sure, reporting and recordkeeping obligations dis-cussed above until 60 days after the effective date of the Proposed Harmonization Rules. The CFTC is expected to finalize the Proposed Harmoniza-tion Rules in the coming months and, therefore, advisers to registered investment companies that have registered as CPOs should expect to begin complying with such CPO disclosure, reporting

and recordkeeping requirements, as amended by

the Proposed Harmonization Rules, in 2013.

4. Compliance With New Reporting Requirements

As part of the final regulations adopted in

February 2012 and referenced above, CPOs and

CTAs are now required to file new Forms CPO-

PQR and CTA-PR, respectively.15 The purpose of

the new forms is for the CFTC to collect addition-

al data with the goal of using such data to more

effectively monitor risks posed by participants in

the commodity futures and derivatives markets.

Forms CPO-PQR and CTA-PR require CPOs and

CTAs, respectively, to disclose information about

their assets under management (AUM), use of

leverage, counterparty credit-risk exposure, and

trading and investment decisions for each com-

modity pool that they direct or advise.

CPOs and CTAs are required to submit Forms

CPO-PQR and CTA-PR quarterly or annually,

depending on their size (i.e., small, mid-size or

large). Whether advisers to private funds that are

registered with both the CFTC and SEC have to

submit the reports quarterly or annually depends

on their AUM. In addition, depending on their

size, as measured by AUM, certain CPOs are

required to complete Form CPO-PQR in its en-

tirety, whereas other CPOs are only required to

complete a portion or portions of the Form CPO-

PQR. All CTAs must complete Form CTA-PR in

its entirety.

Certain large CPOs should have already filed

their first Forms CPO-PQR for the calendar quar-

ter that ended on September 30, 2012. In addi-

tion, many CPOs and all CTAs were required to

file their completed Forms CPO-PQR and CTA-

PR in the first quarter of 2013 for the 2012 calen-

dar year. The CFTC has indicated that additional

guidance with respect to Forms CPO-PQR and

CTA-PR will be issued this year.




5. Additional Relief for Certain Persons From CPO and CTA Requirements

The CFTC staff received numerous requests for no-action relief from the CPO and CTA regis-tration requirements from different types of col-lective investment vehicles, and their operators, that were previously excluded from CFTC over-sight, either because: (1) swaps were previously excluded from the list of commodity interests that can trigger CPO and CTA status; or (2) of the aforementioned amendments impacting CPO

and CTA registration. The CFTC staff issued a series of no-action letters affording relief to broad categories of persons and entities late last year, ranging from real estate investment trusts (RE-ITs) to securitization vehicles, among others. We anticipate that the CFTC staff will continue to af-ford no-action relief in 2013. Whether such relief will be afforded to broad categories of persons remains to be seen; it seems likely that any relief afforded will be applicable to only those persons or entities that have requested it. Certain of the relief afforded to broad categories of persons by the CFTC in 2012 is summarized below.




6. Additional Guidance With Respect to Compliance With CPO and CTA Requirements

The NFA—the self-regulatory organization

to which the CFTC has delegated intermediary

registration and certain oversight functions with respect to CPOs and CTAs—issued guidance in 2012 to facilitate compliance with new CFTC and NFA requirements and will continue to do so in 2013. Relevant guidance provided by the NFA in 2012 is summarized below.




7. Compliance With New Requirements for Swaps Pursuant to the Dodd-Frank Act

Operators of and advisers to commodity pools should be prepared to comply with a range of requirements affecting over-the-counter (OTC) derivatives that will take effect in 2013, to the extent that the pools they operate/advise engage in OTC trading. These requirements will include mandatory clearing, recordkeeping and report-ing of swap transaction data and margin require-ments for uncleared swaps. In addition, certain CPOs may be required to ensure that the com-modity pools they operate abide by position lim-its, to the extent that such pools engage in certain agricultural, energy and/or metals commodity in-terest transactions.• MandatoryClearing. To date, the CFTC has

issued one mandatory clearing determination that applies to certain classes of interest rate swaps and credit default swaps.30 Commod-ity pools are financial entities.31 Therefore, to the extent that a commodity pool engages in interest rate swaps or credit default swaps that fall within the scope of the first mandato-ry clearing determination, it will be required to clear such transactions beginning on June 10, 2013. (“Active” funds, which are private funds (excluding third-party subaccounts) that execute, on average, over the 12 months preceding a final clearing determination, 200 or more swaps per month, were required to begin clearing as of March 11, 2013.)32 Ad-ditional mandatory clearing determinations pertaining to other types of swaps are expect-ed in 2013.

• Recordkeeping and Reporting of SwapTransactionData. The Dodd-Frank Act re-quires that each swap counterparty maintain certain records with respect to the transac-tions in which it engages and report certain information about its swaps to a swap data repository.33 Compliance with the record-keeping requirement is currently required. In addition, there are three types of reporting requirements that apply: (1) general report-ing; (2) real-time reporting; and (3) histori-

cal swaps reporting (“historical” swaps are (1) swaps that were executed prior to the enactment date of the Dodd-Frank Act that remained open after that date; and (2) swaps that were executed in the period between the date of enactment of the Dodd-Frank Act and the relevant compliance date for the general reporting requirements). To the ex-tent that commodity pools engage in swaps with “swap dealers” or “major swap partici-pants” (which are the two new categories of CFTC-registrants created by the Dodd-Frank Act), such counterparties will largely bear the reporting obligation. If a swap dealer or major swap participant is not a counterparty to a commodity pool’s swap, the commodity pool and its counterparty must designate the counterparty that is responsible for report-ing. Commodity pools are also required to have legal entity identifiers, which are neces-sary for reporting, for such activity.

• MarginRequirements forUnclearedSwaps. The Dodd-Frank Act requires the CFTC, the SEC and certain federal banking regulators to establish margin requirements for over-the-counter swaps. The CFTC, the SEC and the federal banking regulators have proposed rules that would establish margin collec-tion requirements for swap dealers and ma-jor swap participants.34 Under the proposed rules, to the extent that a commodity pool’s counterparty is a swap dealer or major swap participant, the commodity pool would be required to post margin for uncleared swaps with zero thresholds. However, none of the CFTC, the SEC or the federal banking regu-lators has finalized its margin rules, and none is expected to do so until later in 2013.

• PositionLimits. In 2011 the CFTC adopted final rules to establish position limits for certain physical commodity futures and for derivatives that are economically equivalent to those futures. The International Swaps and Derivatives Association, Inc., and the Securities Industry and Financial Markets Association initiated a lawsuit against the CFTC claiming that the CFTC violated the




CEA and the APA in adopting the position limits rules because, among other things, the CFTC failed to conduct a proper cost-benefit analysis with respect to the rules and failed to show that position limits are necessary and appropriate.35 The U.S. District Court for the District of Columbia issued a memorandum opinion and order that vacated and remand-ed the position limits rules last September.36 The CFTC has subsequently appealed the de-cision. Accordingly, compliance with the po-sition limits rules is not currently necessary. However, depending on the outcome of the CFTC’s appeal, compliance may be neces-sary in the future. Moreover, the CFTC may repropose position limits rules sometime in 2013. To the extent that new position limits are imposed in the future, CPOs of commod-ity pools that engage in certain agricultural, energy and metals transactions may be re-quired to comply with them.

END NOTES* The authors are members of the corporate

practice group of sutherland Asbill & Brennan LLP in Washington, D.C. The information contained in this article is current as of march 15, 2013.

1. As market participants are aware, CPos are persons that are predominantly engaged in the business of operating a commodity pool, which is a collective investment vehicle that engages in commodity interest trading (i.e., futures, options and, as of october 12, 2012, for the reasons described below, swaps). (A single commodity interest trade can cause an investment vehicle to be a commodity pool.) CTAs are persons that are predominantly engaged in the business of offering advice with respect to the trading of commodity interests for compensation. Both CPos and CTAs must register as such with the Commodity Futures Trading Commission (CFTC), unless they are eligible for an exclusion or exemption therefrom, and are subject to the CFTC’s oversight.

2. 17 C.F.R. § 4.5 (2013).3. 17 C.F.R. § 4.13(a)(4) (2012) (now reserved).4. Commodity Pool operators and Commodity

Trading Advisors: Compliance obligations, 77 Fed. Reg. 11,252 (Feb. 24, 2012) (to be codified at 17 C.F.R. pts. 4, 145 and 147). Correction published march 26, 2012, 77 Fed. Reg. 17,328 (mar. 26, 2012). See also sutherland Asbill & Brennan LLP Legal Alert, CFTC Issues Rules to Increase Oversight of Funds that Invest in

Commodity Interests, available at http://www.regulatoryreformtaskforce.com/files/upload/CFTCIssuesRulestoIncreaseoversightofFunds.pdf.

5. Further Definition of “swap,” “security-Based swap,” and “security-Based swap Agreement”; mixed swaps; security-Based swap Agreement Recordkeeping, 77 Fed. Reg. 48,208 (Aug. 13, 2012) (to be codified at 17 C.F.R. pts. 1, 240 and 241).

6. See note 4, supra.7. Division of Swap Dealer and Intermediary

Oversight Responds to Frequently Asked Questions—CPO/CTA: Amendments to Compliance Obligations, issued on August 14, 2012. Available at http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/faq_cpocta.pdf.

8. CFTC staff Letter no. 12-38 (nov. 29, 2012), available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/12-38.pdf.

9. Complaint, Investment Company Institute and Chamber of Commerce of the United States of America v. United States Commodity Futures Trading Commission, (D.D.C. 2012) (Civil Action no. 1:12-cv-00612), available at http://www.ici.org/pdf/12_commod_inv_complaint.pdf.

10. Inv. Co. Inst. v. United States CFTC, 2012 u.s. Dist. LeXIs 175941, available at http://www.chamberlitigation.com/sites/default/files/cases/files/2012/memorandum%20opinion%20- - % 2 0 I C I % 2 0 v. % 2 0 C F T C % 2 0 ( D . C . % 2 0District%20Court).pdf.

11. notice of Appeal, Investment Company Institute and Chamber of Commerce of the United States of America v. United States Commodity Futures Trading Commission, (D.C. Cir. 2013) (Civil Action no. 1:12-cv-00612), available at http://www.ici.org/pdf/12_commod_inv_noticeofappeal.pdf.

12. emergency motion by Appellants for expedited Consideration of this Appeal and an expedited Briefing schedule, Investment Company Institute and Chamber of Commerce of the United States of America v. United States Commodity Futures Trading Commission, (D.C. Cir. 2013) (Civil Action no. 1:12-cv-00612), available at http://www.ici.org/pdf/26818.pdf.

13. Brief for the Commodity Futures Trading Commission, Investment Company Institute and Chamber of Commerce of the United States of America v. United States Commodity Futures Trading Commission, (D.C. Cir. mar. 8, 2013) (Civil Action no. 1:12-cv-00612), available at http://www.ici.org/pdf/13_cftc_brief_appeal.pdf.

14. harmonization of Compliance obligations for Registered Investment Companies Required to Register as Commodity Pool operators, 77 Fed. Reg. 11,345 (Feb. 24, 2012) (to be codified at 17 C.F.R. pt. 4).

15. See note 4, supra.16. CFTC staff Letter no. 12-40 (Dec. 4, 2012),

available at http://www.cftc.gov/ucm/

Futures & Derivatives Law Report May 2013 n Volume 33 n Issue 5

groups/public/@lrlettergeneral/documents/letter/12-40.pdf.

17. CFTC staff Letter no. 12-37 (nov. 29, 2012), available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/12-37.pdf.

18. CFTC staff Letter no. 12-13 (oct. 11, 2012), available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/12-13.pdf.

19. CFTC staff Letter no. 12-44 (Dec. 7, 2012), available at http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/12-44.pdf.

20. CFTC staff Letter no. 12-14 (oct. 11, 2012), available at http://cftc.gov/LawRegulation/CFTCstaffLetters/12-14.

21. Id. at page 2.22. CFTC staff Letter no. 12-45 (Dec. 7, 2012),

available at http://cftc.gov/LawRegulation/CFTCstaffLetters/12-45.

23. CFTC staff Letter no. 12-67 (Dec. 21, 2012), available at http://cftc.gov/LawRegulation/CFTCstaffLetters/12-67.

24. CFTC staff Letter no. 12-49 (Dec. 11, 2012), available at http://cftc.gov/LawRegulation/CFTCstaffLetters/12-49.

25. nFA notice to members I-12-30, dated December 3, 2012, available at http://www.nfa.futures.org/news/newsnotice.asp?ArticleID=4158.

26. See note 4, supra.27. As of the date of this article, nFA Bylaw 1101

only applies with respect to commodity futures trading and registration as a CPo, CTA, futures commission merchant or introducing broker. The nFA is expected to revise nFA Bylaw 1101 in 2013 to include swaps, swap dealers and major swap participants.

28. See nFA Interpretive notice 9007, available at http://www.nfa.futures.org/nfamanual/nFAmanual.aspx?RuleID=9007&section=9.

29. nFA notice to members I-12-34, dated December 9, 2012, available at http://www.nfa.futures.org/news/newsnotice.asp?ArticleID=4170.

30. Clearing Requirement Determination under section 2(h) of the CeA, 77 Fed. Reg. 74,284 (Dec.

13, 2012) (to be codified at 17 C.F.R. pts. 39 and 50). See also sutherland Asbill & Brennan LLP Legal Alert, CFTC Issues First Set of Mandatory Clearing Determinations and Time-Limited No-Action Relief, available at http://www.regulatoryreformtaskforce.com/files/upload/CFTCIssuesFirstsetofmandatory ClearingDeterminationsandTimeLimitednoAction Relief.pdf.

31. See CeA section 2(h)(7), 7 u.s.C. § 2(h)(7) (2013).

32. See note 30, supra.33. See CeA section 4r, 7 u.s.C. § 6r (2013).34. margin and Capital Requirements for Covered

swap entities, 76 Fed. Reg. 27,564 (may 11, 2011) (to be codified at 12 C.F.R. pts. 45, 237, 324, 624 and 1221); margin Requirements for uncleared swaps for swap Dealers and major swap Participants, 76 Fed. Reg. 23,732 (Apr. 28, 2011) (to be codified at 17 C.F.R. pt. 23); Capital Requirements of swap Dealers and major swap Participants, 76 Fed. Reg. 27,802 (may 12, 2011) (to be codified at 17 C.F.R. pts. 1, 23 and 140); Capital, margin, and segregation Requirements for security-Based swap Dealers and major security-Based swap Participants and Capital Requirements for Broker-Dealers, 77 Fed. Reg. 70, 214 (nov. 23, 2012) (to be codified at 17 C.F.R. pt. 240) (correction published December 3, 2012, 77 Fed. Reg. 71,568 (Dec. 3, 2012)

35. Complaint, International Swaps and Derivatives Association and Securities Industry and Financial Markets Association v. United States Commodity Futures Trading Commission, (D.D.C. 2012) (Civil Action no. 1:11-cv-02146), available at http://www.sifma.org/workarea/downloadasset.aspx?id=8589936641.

36. International Swaps and Derivatives Association and Securities Industry and Financial Markets Association v. United States Commodity Futures Trading Commission, 887 F. supp. 2d 259 (D.D.C. 2013), available at https://ecf.dcd.uscourts.gov/cgi-bin/show_public_doc?2011cv2146-69.

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