Clarity needed on CFTC registration requirements for funds of funds

19 Jul, 2012

The CFTC must clarify whether funds of hedge funds are exempt from its registration requirements, a leading US law firm has said.

Hedge funds and other buy-side firms trading certain swaps will need to register as Commodity Pool Operators (CPOs) with the CFTC following the repeal of Regulation 4.13(a)(4) although exemptions will remain for managers executing an insignificant number of swaps trades under Regulation 4.13(a)(3).

David Efron, partner at Schulte Roth & Zabel in New York, said there has been very little guidance from the CFTC on how funds of funds can comply with the Regulation 4.13(a)(3) exemption. “Funds of funds need to identify whether their underlying funds meet the de minimis requirements outlined by the CFTC, which may be a burdensome process. In the past this was less of a concern as many funds of funds were able to rely on the Regulation 4.13(a)(4) exemption which placed no restriction on commodity interest trading levels,” he said.

Efron said the CFTC needed to issue formal guidance in good time to enable funds of funds to ascertain whether they need to register as CPOs. Managers must register with the CFTC by December 31, 2012, which could be a challenge if the uncertainty continues. “The CFTC has reiterated that it will not extend the December 31 deadline which means some registrations could be quite tight,” said Efron.

The CFTC and SEC have only just agreed on the definition of a swap – something which should have been done months ago. Some experts are therefore doubtful the CFTC will give details on the status of funds of funds anytime soon.  Others believe funds of funds will not be exempted from the rules at all. Cary Meer, partner at K&L Gates in Washington DC, speaking several weeks ago, said an exemption was unlikely given the current regulatory and political climate in the US.

The rules are also extraterritorial and will apply to non-US funds of funds and managers with American investors and those trading commodity interests including foreign futures and swaps, added Efron.

The CFTC and SEC agreed last week that 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.

“The new swap definition takes a broad view regarding what is considered a swap subject to the CFTC’s jurisdiction. I believe a lot of hedge funds and funds of funds may be surprised when they discover how expansive the definition is and, as such, that they may not fit within the de minimis exemption,” commented Efron.

Managers will also be required to become National Futures Association (NFA) members to continue trading. Fund managers would then be subject to additional disclosure, reporting and occasional NFA audits.