Commodity Futures Trading Commission Update

Tuesday, October 23, 2012 - 10:29

CFTC Amends CPO And CTA Rules; NFA Adopts Test Waiver And Swap De​signation For Members  

The Commodity Futures Trading Commission (CFTC) recently broadened the scope of its rules governing the operations and activities of commodity pool operators and commodity trading advisors that engage in swap transactions.[1]  Additionally, National Futures Association has amended its membership and proficiency requirements with respect to entities that engage in swap transactions and persons associated with such entities.[2]  The NFA Amendments, among other things, exempt certain persons from taking the Series 3 examination.

The CFTC Amendments are effective November 5, 2012.  While the amendments to NFA’s membership requirements are effective January 1, 2013, the amendments to its proficiency requirements are effective immediately.

CFTC Amendments

Currently, certain CFTC rules apply to CPO and CTA activities involving only “futures contracts, commodity options, and off-exchange retail foreign currency.”  The CFTC Amendments will make such rules applicable to CPO and CTA swap trading activities as well.[3]  The CFTC Amendments will revise:

  • CFTC Rule 4.7(a)(2) to include “a registered swap dealer” within the definition of “qualified eligible person”;
  • CFTC Rule 4.22 to require disclosure in a pool’s periodic account statement of any previously undisclosed material business dealings between the pool’s swap dealer and, among others, the pool, its CPO, CTA, futures commission merchant (“FCM”), or any principals thereof;
  • CFTC Rules 4.23 and 4.33 to require CPOs and CTAs, respectively, to retain swap dealer monthly statements and maintain records that identify for each swap the swap type and counterparty;[4]
  • CFTC Rule 4.24 to generally require a CPO to disclose, among other things, the pool’s assets allocated to swap transactions, the risks and costs associated with swap transactions, any conflicts and certain litigation involving any swap dealer engaged by the pool;
  • CFTC Rule 4.34 to generally require a CTA to disclose, among other things, the risks and fees associated with swap transactions, any conflicts involving any swap dealer engaged by the CTA and certain litigation brought against any introducing broker (“IB”) through which the client will be required to introduce its account to a swap dealer;[5] and
  • CFTC Rule 4.30 to exempt a registered swap dealer engaged in an over-the-counter swap transaction from the general prohibition against CTAs collecting margin from clients.[6]

NFA Amendments

Swap Firm; Swap AP Designation. NFA Bylaw 301 generally governs NFA’s membership criteria and eligibility requirements.  The NFA Amendments will require that any registered FCM, IB, CPO or CTA (each, an “NFA Member”) that engages in activities involving swaps be approved by NFA as a “swaps firm” (“Swap Firm”).  Any person who is associated with, and who engages in swap activities on behalf of, a Swap Firm must be approved as a “swaps-associated person” (“Swap AP”).[7]  Any request for approval as a Swap Firm or a Swap AP (or a withdrawal of such approval) must be filed electronically via NFA’s Online Registration System.

New Test Waivers. NFA Rule 401 generally governs the proficiency requirements for APs.  Since current proficiency examinations do not cover swaps, NFA has amended Rule 401 to provide that an AP who limits his or her activities to swaps will not need to pass any proficiency examination (e.g., the Series 3).  Specifically, the NFA Amendments provide that a Swap AP need not pass a proficiency examination if the person will be responsible for soliciting only (1) orders for swaps, (2) discretionary accounts that exclusively trade swaps and are managed by registered CTAs or (3) funds for participation in a commodity pool that either exclusively trades swaps or trades swaps and a de minimis amount of other commodity interests.  Any person who supervises only other persons whose activities are so limited will be exempt from the proficiency requirement as well.

If an AP wishes to be exempt from the proficiency requirement because he or she solicits funds for a commodity pool that trades swaps and a de minimis amount of other commodity interests, the AP’s sponsor must apply to NFA for a waiver under NFA Rule 402.  Rule 402 also requires a Swap Firm to notify NFA whenever a Swap AP for whom it has received a waiver can no longer satisfy the conditions of such waiver.

Court Vacates And Remands CFTC Position Limit Rule

On September 28, 2012, the United States District Court for the District of Columbia vacated the CFTC’s controversial new rules on speculative position limits (i.e., Part 151) and remanded them to the CFTC.[8]  The district court, however, did not vacate the amendment to CFTC Rule 150.2, which increased certain pre-existing speculative position limits.  As a result, the current rules governing speculative position limits (i.e., Part 150), including amended Rule 150.2, will remain in effect for now.

At the heart of the district court’s decision to vacate Part 151 was that the Commodity Exchange Act (“CEA”), as modified by the Dodd-Frank Act,[9] was ambiguous as to whether the CFTC was required to make a determination that the new position limits were “necessary and appropriate” prior to imposing them.  Since the CFTC promulgated Part 151 based on the “erroneous conclusion” that the CEA was not ambiguous on this point, the district court vacated Part 151 and remanded it to the CFTC for further consideration.

The rules took effect on October 12, 2012.  The CFTC will now have to determine whether to re-promulgate Part 151 consistent with the district court’s opinion. 

CFTC Releases Guidance For CPOs And CTAs

The CFTC Division of Swap Dealer and Intermediary Oversight recently published guidance for commodity pool operators and commodity trading advisors impacted by the CFTC’s rescission of Rule 4.13(a)(4) and amendments to Rule 4.5.  Rule 4.13(a)(4) was a registration exemption relied upon by many hedge fund managers.  Rule 4.5 provides an exclusion from the definition of CPO for, among others, registered investment companies (“RICs”) that trade a de minimis level of commodity interests that do not constitute bona fide hedging.  Highlights of the guidance are below.

  1. A general partner, managing member or board of directors may delegate its CPO rights and obligations to another person that is qualified to serve as CPO and is registered as a CPO with the CFTC.  The delegating entity will remain jointly and severally liable for violations of the Commodity Exchange Act.  The CPO to which responsibility is delegated need not be under common control with the delegating entity.  Presumably others similarly situated, such as the trustee of a trust, may also delegate responsibility to a qualified CPO.
  2. A wholly owned subsidiary of a commodity pool that trades in derivatives itself, including a CFC of a RIC, is itself a commodity pool.
  3. The CPO for a RIC and its CFC generally should be the same entity.
  4. With respect to CPOs and CTAs of RICs only, although registration will be required by December 31, 2012, compliance with the CFTC’s disclosure, recordkeeping and reporting requirements will be deferred until after the CFTC adopts final rules implementing its harmonization proposal.
  5. Swaps have to be included in the Rule 4.5 and Rule 4.13(a)(3) de minimis thresholds as of December 31, 2012.  For purposes of these de minimis tests, the notional value of a swap will be the notional amount reported pursuant to Part 45.
  6. A CPO may be able to rely on Rule 4.13(a)(3) with respect to a vehicle that will predominantly invest in nonderivatives even if the vehicle’s initial sole position is a swap.  The CPO will have a “reasonable time” to come into compliance with the limits of that rule.
  7. Prior Commission guidance regarding the application of Rule 4.13(a)(3) in the fund-of-funds context will remain in effect until new guidance is adopted.
  8. CPOs that register as of January 1, 2013, will become subject to the annual report filing requirement for fiscal year 2013.
  9. The Staff expects that NFA’s systems will soon permit CPOs with pending registrations to file claims of exemption prior to December 31, 2012, with an effective date of January 1, 2013  (e.g., Rule 4.7 or Advisory 18-96 notices).
  10. The Staff reiterated the Commission’s current position that equitization of cash and risk management do not constitute bona fide hedging for purposes of Rule 4.5.
  11. CPOs that claimed and have continued to rely upon the CFTC’s November 2002 no-action relief prior to the adoption of Rules 4.13(a)(3) and (4) must either claim the 4.13(a)(3) exemption (if available) or register with the CFTC.  Such claims of exemption will be subject to the new annual affirmation requirement.

[1]     Amendments to Commodity Pool Operator and Commodity Trading Advisor Regulations Resulting from the Dodd-Frank Act, 77 Fed. Reg. 54355 (Sept. 5, 2012) (the “CFTC Amendments”). 

[2]     National Futures Association: Swap Registration Requirements—Proposed Amendments to Bylaw 301 and Registration Rules 401 and 402, available at (the “NFA Amendments”); see also NFA Notice to Members I-12-24, Effective Dates of Amendments to NFA Bylaw 301 and Registration Rules 401 and 402 Regarding Swap Registration Requirements for FCMs, IBs, CPOs, CTAs and APs (October 3, 2012).

[3]     The CFTC Amendments, as originally proposed, would have added “commodity interest” as a defined term in CFTC Rule 4.10(a), which would have included, among other things, any “swap.”  This definition would have applied only to the CFTC’s rules regulating CPOs and CTAs, but was not adopted.  Instead, the CFTC superseded that proposal with a proposed amendment to the definition of “commodity interest” in CFTC Rule 1.3(yy), which, if adopted as proposed, will add “swap” to that definition and will therefore apply across all CFTC rules.

[4]     If a CPO or CTA is a counterparty to a swap, it must comply with the reporting and recordkeeping requirements of the CFTC’s Part 45 rules.

[5]     Rule 4.34 was not amended to require the disclosure of litigation brought against a swap dealer engaged by a CTA.  Nevertheless, such litigation would have to be disclosed if it is otherwise material under Rule 4.34(o).

[6]     The CFTC has indicated that a swap dealer could meet the statutory definition of CTA in the Commodity Exchange Act.  Accordingly, in addition to amending Rule 4.30, the CFTC has also recently amended CFTC Rule 4.6 to exclude a swap dealer from the definition of CTA if its advisory activities are solely incidental to its business as a swap dealer.

[7]     NFA Bylaw 301 will also require a Swap Firm to have at least one principal that is registered as an associated person (“AP”) and approved as a Swap AP.  If a Swap Firm fails to meet this requirement, such failure will be deemed a request to withdraw the member’s Swap Firm designation.

[8]     For more information on Part 151, please see Willkie client memoranda entitled “CFTC Adopts Final Rules on Position Limits; Independent Account Controller Exemption Retained” and “CFTC Adopts Final Rules on Position Limits,” dated October 19, 2011, and November 17, 2011, respectively.

[9]     Part 151 was implemented pursuant to Section 737 of The Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111- 203, H.R. 4173, enacted July 16, 2011.

Rita M. Molesworth is a Partner in the Corporate and Financial services Department of Willkie Farr & Gallagher LLP in New York and is a member of the Firm’s Asset Management, Regulatory and Capital Markets Practice Groups. Deborah A. Tuchman is Of Counsel in the Asset Management Group of Willkie Farr & Gallagher LLP in New York and is a member of the Firm’s Financial Institutions Regulatory Practice Group.

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