CFTC clarifications on CPO registration welcome but challenges remain

InvestorsLegalOperational RiskRegulation
21 Aug, 2012

Clarifications made by the CFTC on Commodity Pool Operator (CPO) registration have resolved some of the confusion for fund of funds but complexities still remain, a US law firm has said.

CFTC issued FAQs but made few concessions

The CFTC published FAQs last week. This came amid complaints from fund of funds that regulators had not been wholly clear on how firms could claim the Regulation 4.13(a)(3) exemption, which applies to managers engaging in de minimis levels of trading in CFTC-regulated instruments.  The lack of clarity was all the more urgent given the tight December 31, 2012 deadline.

“The formal guidance is welcome. As things stand, a fund of funds can rely on the guidance that had been previously outlined in Appendix A relating to the Regulation 4.13(a)(3) exemption which was omitted when the CFTC promulgated the recent rules repealing the Regulation 4.13(a)(4) exemption.  Appendix A outlines the methods in which managers to fund of funds can avail themselves of the exemption,” said David Efron, partner at Schulte Roth & Zabel (SRZ) in New York.

A clerical error by the CFTC appeared to have sowed the confusion. Regulators removed Appendix A from the initial draft but forgot to include it in the amended versions. While this mistake has been rectified, challenges still exist for funds of funds.

“Although the Appendix A clarification is helpful guidance, the rules are in no way less burdensome for funds of funds as they will still need to get the relevant information from all of their underlying hedge funds. That has not changed,” commented Efron.

If a fund of funds wants to claim an exemption, it will be required to obtain a certification from all of its underlying managers acknowledging the funds rely on the de-minimis trading exemption. Alternatively, a fund of funds can ascertain whether it meets the exemption’s trading level requirements mathematically based on the certifications it receives from its underlying managers.

Funds of funds are unlikely to get a full exemption given the current regulatory zeal.

The FAQ does, however, ease some of the investor reporting requirements, which has been welcomed by some managers. “The FAQ clarified that funds which are transitioning from the Regulation 4.13(a)(4) exemption to the Regulation 4.7 exemption will not have to reaffirm that existing investors in the fund meet the qualified eligible person standard in order for the registered CPO to claim the Regulation 4.7 exemption. Managers will only be required to do this for new investors,” said Efron.

The CFTC and SEC agreed earlier in the month hedge funds trading interest rate swaps, OTC foreign currency options, commodity options, non-deliverable forwards in FX, cross-currency swaps, forward rate agreements, contracts for difference and total return swaps on underlying commodity interests, options to enter into swaps and forwards swaps are all subjected to the rules.

Fund managers who do not meet the de minimis exemption will be required to register with the CFTC and become National Futures Association (NFA) members in order to continue trading in CFTC-regulated instruments. . Those fund managers would then be subject to additional disclosure, reporting and occasional NFA audits.