Commodity Pool Operators and Commodity Trading Advisors

94 Pages·2016·11.17 MB·English

Vol. 77 Friday,
No. 37 February 24, 2012
Part III
Commodity Futures Trading Commission
17 CFR Parts 4, 145, and 147
Commodity Pool Operators and Commodity Trading Advisors: Compliance
Obligations; Harmonization of Compliance Obligations for Registered
Investment Companies Required To Register as Commodity Pool
Operators; Final Rule and Proposed Rule
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11252 Federal Register/Vol. 77, No. 37/Friday, February 24, 2012/Rules and Regulations
COMMODITY FUTURES TRADING proposed rulemaking. CPOs claiming (‘‘SEC’’), and created new financial
COMMISSION exemption under §4.13(a)(4) shall be regulatory entities.
required to comply with the rescission In addition to the expansion of the
17 CFR Parts 4, 145, and 147 of §4.13(a)(4) by December 31, 2012; Commission’s jurisdiction to include
however, compliance shall be required swaps under Title VII of the Dodd-Frank
RIN 3038–AD30
for all other CPOs on April 24, 2012. Act, Title I of the Dodd-Frank Act
Commodity Pool Operators and Compliance with all other amendments, created the Financial Stability Oversight
Commodity Trading Advisors: not otherwise specified above, shall be Council (‘‘FSOC’’).3The FSOC is
Compliance Obligations required by December 31, 2012. composed of the leaders of various state
FORFURTHERINFORMATIONCONTACT: and federal financial regulators and is
AGENCY: Commodity Futures Trading Kevin P. Walek, Assistant Director, charged with identifying risks to the
Commission. financial stability of the United States,
Telephone: [phone], Email:
ACTION: Final rule. promoting market discipline, and
[email protected], or Amanda Lesher
responding to emerging threats to the
SUMMARY: The Commodity Futures Olear, Special Counsel, Telephone:
stability of the country’s financial
Trading Commission is adopting (202) 418–5283, Email: [email protected],
system.4The Dodd-Frank Act
amendments to its existing part 4 Michael Ehrstein, Attorney-Advisor,
anticipates that the FSOC will be
regulations and promulgating one new Telephone: [phone], Email:
supported in these responsibilities by
regulation regarding Commodity Pool [email protected], Division of Swap
the federal financial regulatory
Operators and Commodity Trading Dealer and Intermediary Oversight,
agencies.5The Commission is among
Advisors. The Commission is also Commodity Futures Trading
those agencies that could be asked to
adopting new data collections for CPOs Commission, Three Lafayette Centre,
provide information necessary for the
and CTAs that are consistent with a data 1155 21st Street NW., Washington, DC
FSOC to perform its statutorily
collection required under the Dodd- 20581.
mandated duties.6
Frank Act for entities registered with SUPPLEMENTARYINFORMATION: Title IV of the Dodd-Frank Act
both the Commission and the Securities
I. Background on the Proposal To requires advisers to large private funds7
and Exchange Commission. The
Amend the Registration and to register with the SEC.8Through this
adopted amendments rescind the
Compliance Obligations for CPOs and registration requirement, Congress
exemption from registration; rescind
CTAs
relief from the certification requirement
3See section 111 of the Dodd-Frank Act.
for annual reports provided to operators A. Statutory and Regulatory Background
4See section 112(a)(1)(A) of the Dodd-Frank Act.
of certain pools offered only to qualified On July 21, 2010, President Obama 5See sections 112(a)(2)(A) and 112(d)(1) of the
eligible persons (QEPs; modify the Dodd-Frank Act.
signed the Dodd-Frank Wall Street
criteria for claiming relief); and require 6See section 112(d)(1) of the Dodd-Frank Act.
Reform and Consumer Protection Act
the annual filing of notices claiming 7Section 202(a)(29) of the Investment Advisers
(‘‘Dodd-Frank Act’’).1The legislation Act of 1940 (‘‘Investment Advisers Act’’) defines the
exemptive relief under several sections
was enacted to reduce risk, increase term ‘‘private fund’’ as ‘‘an issuer that would be an
of the Commission’s regulations. transparency, and promote market investment company, as defined in section 3 of the
Finally, the adopted amendments Investment Company Act of 1940 (15 U.S.C. 80a–
integrity within the financial system by,
include new risk disclosure 3), but for section 3(c)(1) or 3(c)(7) of that Act.’’ 15
inter alia, enhancing the Commodity U.S.C. 80a–3(c)(1), 80a–3(c)(7). Section 3(c)(1) of
requirements for CPOs and CTAs
Futures Trading Commission’s (the the Investment Company Act provides an exclusion
regarding swap transactions. ‘‘Commission’’ or ‘‘CFTC’’) rulemaking from the definition of ‘‘investment company’’ for
DATES: Effective dates: This final rule is and enforcement authorities with any ‘‘issuer whose outstanding securities (other
than short term paper) are beneficially owned by
effective on April 24, 2012, except for
respect to all registered entities and not more than one hundred persons and which is
the amendments to §4.27, which shall intermediaries subject to the not making and does not presently propose to make
become effective on July 2, 2012. Commission’s oversight. a public offering of its securities.’’ 15 U.S.C. 80a–
Compliance dates: Compliance with 3(c)(1). Section 3(c)(7) of the Investment Company
The preamble of the Dodd-Frank Act
Act provides an exclusion from the definition of
§4.27 shall be required by not later than
explicitly states that the purpose of the ‘‘investment company’’ for any ‘‘issuer, the
September 15, 2012, for a CPO having legislation is: outstanding securities of which are owned
at least $5 billion in assets under exclusively by persons who, at the time of
management, and by not later than To promote the financial stability of the acquisition of such securities, are qualified
United States by improving accountability purchasers, and which is not making and does not
December 14, 2012, for all other
and transparency in the financial system, to at that time propose to make a public offering of
registered CPOs and all CTAs. end ‘too big to fail’, to protect the American such securities.’’ 15 U.S.C. 80a–3(c)(7). The term
Compliance with §4.5 for registration taxpayer by ending bailouts, to protect ‘‘qualified purchaser’’ is defined in section 2(a)(51)
purposes only shall be required not later consumers from abusive financial services of the Investment Company Act. See 15 U.S.C. 80a–
2(a)(51).
than the later of December 31, 2012, or practices, and for other purposes.2
8The Dodd-Frank Act requires private fund
60 days after the effective date of the Pursuant to this stated objective, the
adviser registration by amending section 203(b)(3)
final rulemaking further defining the Dodd-Frank Act has expanded the scope of the Advisers Act to repeal the exemption from
term ‘‘swap,’’ which the Commission of federal financial regulation to include registration for any adviser that during the course
will publish in the Federal Register at instruments such as swaps, enhanced of the preceding 12 months had fewer than 15
clients and neither held itself out to the public as
a future date. Entities required to the rulemaking authorities of existing
an investment adviser nor advised any registered
register due to the amendments to §4.5 federal financial regulatory agencies investment company or business development
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RO days following the effectiveness of a Consumer Protection Act, Public Law 111–203, 124 States. There also is an exemption for foreign
N1P final rule implementing the Stat. 1376 (2010). The text of the Dodd-Frank Act advisers with less than $25 million in assets under
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SK4 effort pursuant to the concurrent 2Id. sections 402, 407 and 408 of the Dodd-Frank Act.
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Federal Register/Vol. 77, No. 37/Friday, February 24, 2012/Rules and Regulations 11253
sought to make available to the SEC purposes of the CEA.’’17In addition, the B. The Proposal
‘‘information regarding [the] size, Commission has the authority to ‘‘make
Following the recent economic
strategies and positions’’ of large private and promulgate such rules and turmoil, and consistent with the tenor of
funds, which Congress believed ‘‘could regulations as, in the judgment of the the provisions of the Dodd-Frank Act,
be crucial to regulatory attempts to deal Commission, are reasonably necessary the Commission reconsidered the level
with a future crisis.’’9In section 404 of to effectuate the provisions or to of regulation that it believes is
the Dodd-Frank Act, Congress amended accomplish any of the purposes of [the appropriate with respect to entities
section 204(b) of the Investment CEA].’’18The Commission’s participating in the commodity futures
Advisers Act to direct the SEC to require discretionary authority to exclude or and derivatives markets. Therefore, on
private fund advisers registered solely exempt persons from registration was January 26, 2011, the Commission
with the SEC10to file reports containing intended to be exercised ‘‘to exempt proposed amendments and additions to
such information as is deemed from registration those persons who its existing regulatory regime for CPOs
necessary and appropriate in the public otherwise meet the criteria for and CTAs and the creation of two new
interest and for investor protection or registration * * * if, in the opinion of data collection instruments, Forms
for the assessment of systemic risk. the Commission, there is no substantial CPO–PQR and CTA–PR (‘‘Proposal’’).23
These reports and records must include public interest to be served by the In a concurrent joint proposal with the
a description of certain prescribed registration.’’19It is pursuant to this SEC, the Commission also proposed
information, such as the amount of authority that the Commission has §4.27(d) and sections 1 and 2 of Form
assets under management, use of promulgated the various exemptions PF.24
leverage, counterparty credit risk from registration as a CPO that are In the Proposal, the Commission
exposure, and trading and investment enumerated in §4.13 of its regulations specifically proposed the following
positions for each private fund advised as well as the exclusions from the amendments: (A) to require the periodic
by the adviser.11Section 406 of the definition of CPO that are delineated in reporting of data by CPOs and CTAs
Dodd-Frank Act also requires that the §4.5.20 regarding their direction of commodity
rules establishing the form and content As stated previously in this release, pool assets; (B) to identify certain
of reports filed by private fund advisers and in the Proposal, Congress enacted proposed filings with the Commission
that are dually registered with the SEC the Dodd-Frank Act in response to the as being afforded confidential treatment;
and the CFTC be issued jointly by both financial crisis of 2007 and 2008.21That (C) to revise the requirements for
agencies after consultation with the Act requires the reporting of certain determining which persons should be
FSOC.12 information by investment advisers to required to register as a CPO under
private funds related to potential §4.5; (D) to require the filing of certified
The Commodity Exchange Act
systemic risk including, but not limited annual reports by all registered CPOs;
(‘‘CEA’’)13authorizes the Commission
to, the amount of assets under (E) to rescind the exemptions from
to register Commodity Pool Operators
management, use of leverage, registration under §§4.13(a)(3) and
(‘‘CPOs’’) and Commodity Trading
counterparty credit risk exposure, and (a)(4); (F) to require annual affirmation
Advisors (‘‘CTAs’’),14exclude any entity
trading and investment positions for of claimed exemptive relief for both
from registration as a CPO or CTA,15
each private fund under the reporting CPOs and CTAs; (G) to require an
and require ‘‘[e]very commodity trading
advisor and commodity pool operator entity’s advisement.22This information additional risk disclosure statement
registered under [the CEA to] maintain facilitates oversight of the investment from CPOs and CTAs that engage in
books and records and file such reports activities of funds within the context of swaps transactions; and (H) to make
in such form and manner as may be the rest of a discrete market or the certain conforming amendments to the
prescribed by the Commission.’’16The economy as a whole. Commission’s regulations in light of the
Commission also has the authority to The sources of risk delineated in the proposed amendments.
include within or exclude from the Dodd-Frank Act with respect to private In describing the rationale for the
definitions of ‘‘commodity pool,’’ funds are also presented by commodity Proposal, the Commission stated:
‘‘commodity pool operator,’’ and pools. To provide the Commission with [T]o ensure that necessary data is collected
‘‘commodity trading advisor’’ any entity similar information to address these from CPOs and CTAs that are not operators
‘‘if the Commission determines that the risks, the Commission has determined or advisors of private funds, the Commission
rule or regulation will effectuate the to require registration of certain is proposing a new §4.27, which would
require quarterly reports from all CPOs and
previously exempt CPOs and to further
CTAs to be electronically filed with NFA.
require reporting of information
9See S. Conf. Rep. No. 111–176, at 38 (2010). The Commission is promulgating proposed
10In this release, the term ‘‘private fund adviser’’ comparable to that required in Form PF, §4.27 pursuant to the Commission’s
means any investment adviser that is (i) registered which the Commission has previously authority to require the filing of reports by
or required to be registered with the SEC (including adopted jointly with the SEC. To registered CPOs and CTAs under section 4n
any investment adviser that is also registered or implement this enhanced oversight, the
required to be registered with the CFTC as a CPO
or CTA) and (ii) advises one or more private funds Commission proposed, and has now 23See 76 FR 7976 (Feb. 11, 2011).
(including any commodity pools that satisfy the determined to adopt, the revision and 24See 76 FR 8068 (Feb. 11, 2011). Because the
definition of ‘‘private fund’’). rescission of certain discretionary Commission did not adopt the remainder of
11See section 404 of the Dodd-Frank Act. exemptions that it previously granted. proposed §4.27 at the same time as it adopted the
subsection of §4.27 implementing Form PF, the
12See section 406 of the Dodd-Frank Act.
Commission modified the designation of §4.27(d)
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RO CPOs have reporting obligations with respect to 20See 68 FR 47231 (Aug. 8, 2003). (2) allow CPOs and CTAs who are otherwise
N1P their operated pools. See 17 CFR. 4.22. Although 21See Dodd-Frank Wall Street Reform and required to file Form PF the option of submitting
TV CTAs have recordkeeping obligations under part 4, Consumer Protection Act, Pub. L. 111–203, 124 on Form PF data regarding commodity pools that
VP the Commission has not required reporting by Stat. 1376 (2010). are not private funds as substitute compliance with
SK4 CTAs, See generally, 17 CFR. part 4. 22See section 404 of the Dodd-Frank Act. certain CFTC reporting obligations.
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11254 Federal Register/Vol. 77, No. 37/Friday, February 24, 2012/Rules and Regulations
of the CEA. In an effort to eliminate Commission is making in response amendments to §4.5. The comments can
duplicative filings, proposed §4.27(d) would thereto. The Commission encourages be broadly categorized into eight
allow certain CPOs and/or CTAs that are also interested persons to read the Proposal categories: (1) General comments as to
registered as private fund advisers with the
for a fuller discussion of the purpose of the advisability of making such a change
SEC pursuant to the securities laws to satisfy
each of the amendments contained in and the Commission’s justification for
certain of the Commission’s systemic
the Proposal. doing so; (2) the trading threshold; (3)
reporting requirements by completing and
filing the appropriate sections of Form PF D. Significant Changes From the the inclusion of swaps within the
with the SEC with respect to advised private trading threshold; (4) the proposed
Proposal
funds. marketing restriction; (5) harmonization
In order to ensure that the Commission can The significant changes from the of compliance obligations with those of
adequately oversee the commodities and Proposal that the Commission is making the SEC; (6) the appropriate entity to
derivatives markets and assess market risk in the rules it is adopting today are as register as the registered investment
associated with pooled investment vehicles follows: (1) The marketing restriction in company’s CPO; (7) the use and
under its jurisdiction, the Commission is re- §4.5 no longer contains the clause ‘‘(or permissibility of controlled foreign
evaluating its regulation of CPOs and CTAs.
otherwise seeking investment exposure corporations by registered investment
Additionally, the Commission does not want
to)’’; (2) §4.5 will be amended to companies; and (8) the timeline for
its registration and reporting regime for
pooled investment vehicles and their include an alternative trading threshold implementation.
test based on the net notional value of
operators and/or advisors to be incongruent
1. General Comments on Proposed
with the registration and reporting regimes of a registered investment company’s
Amendments to §4.5
other regulators, such as that of the SEC for derivatives positions; (3) annual notices
investment advisers under the Dodd-Frank for exemptions and exclusions will be Certain comments argued against the
Act. (Footnotes omitted).25 filed on an annual calendar year end adoption of any change to §4.5 and
basis rather than on the anniversary of questioned the Commission’s
C. Comments on the Proposal
the filing date; and (4) changes have justification for doing so.30Most
The Commission received 61
been made to the substance of Forms commenters generally opposed the
comment letters in response to the
CPO–PQR and CTA–PR and the filing change because they claimed that
Proposal. The commenters represented a
timelines for both forms. requiring registration and compliance
diversity of market participants. Seven
with the Commission’s regulatory
commenters were registered investment II. Responses to Comments on the
regime would provide no tangible
companies or registered investment Proposal
benefit to the Commission or investors
advisers; five commenters were A. Comments Regarding Proposed because registered investment
registered or exempt CPOs; and three Amendments to §4.5 companies are already subject to
commenters were registered investment
As part of the Proposal, the comprehensive regulation by the SEC.
companies or registered investment The Commission believes that
Commission proposed amendments to
advisers that also claimed exemption registration with the Commission
§4.5(c)(2)(iii), reinstating a trading
from registration as a CPO under §4.13. provides two significant benefits. First,
threshold and marketing restriction for
The Commission also received 20 registration allows the Commission to
registered investment companies
comments from law firms; 14 comments ensure that all entities operating
claiming exclusion from the definition
from trade organizations; two comments collective investment vehicles
of CPO under that section. In support of
from individual interested parties; a participating in the derivatives markets
the Proposal, the Commission stated
comment from a compliance service meet minimum standards of fitness and
that it became aware that certain
provider; and a comment from a competency.31Second, registration
registered investment companies were
registered futures association.26The provides the Commission and members
offering interests in de facto commodity
majority of the comments received of the public with a clear means of
pools while claiming exclusion under
opposed the adoption of the proposed addressing wrongful conduct by
§4.5.27The Commission further stated
amendments to §4.5 and the rescission individuals and entities participating in
that it believed that registered
of §§4.13(a)(3) and (a)(4). the derivatives markets. The
Having considered these comments, investment companies should not
Commission has clear authority to take
the Commission has decided to adopt engage in such activities without
punitive and/or remedial action against
most of the amendments to part 4 that Commission oversight and that such
registered entities for violations of the
it proposed, with some modifications. In oversight was necessary to ensure
CEA or of the Commission’s regulations.
addition, the Commission has decided consistent treatment of CPOs regardless
Moreover, the Commission has the
not to rescind the exemption in of their status with respect to other
ability to deny or revoke registration,
§4.13(a)(3) for entities engaged in a de regulators.28The Commission also
thereby expelling an individual or entity
minimis amount of derivatives trading. recognized that operational issues may
from serving as an intermediary in the
The Commission’s amendments to part exist regarding the ability of registered
industry. Members of the public also
4, and the modifications to its Proposal investment companies to comply with
may access the Commission’s
are discussed below. the Commission’s compliance regime.29
reparations program or National Futures
The scope of this Federal Register The Commission received numerous
Association’s (‘‘NFA’’) arbitration
release generally is restricted to the comments regarding the proposed
program to seek redress for wrongful
comments received in response to the
conduct by a Commission registrant
ULES2 Pclraorpifoicsaalt iaonnds toof ,t thhee c Phraonpgoessa tlo t,h aant dth teh e C§o42m.757 mf6oi lsFlsoRiwo 7ni9n d7ge6 tt,he 7re9m s8ui3nb e(mFdei tsbos. i p1or2no, op2fo0 as1e 1p a)e.m tTitehinoedn m foern ts to 30Comment letter from the Investment Company
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RO 26Additionally, the Commission received six direct oversight activities relating to CPOs, CTAs, 12, 2011) (‘‘MFDF Letter’’).
TVN1P coof mthme ePnrotsp tohsaatl .w Tehrree ne octo pnecretrinneedn tp toos tihtieo nsu lbimstiatns cien a2n0d10 c)o. mmodity pools. See, 75 FR 56997 (Sept. 17, Se3s1s.S 4e8e H(1.9R8. 2R),e pS.. NReop. .5 N65o .( P3a8r4t, 19)7, t9h7 Ctho nCgo.n, g2.d, 2d
VP silver, one consisted of a web address; one was an 28Id. at 7984. Sess. 111 (1982). See also, 48 FR 14933 (Apr. 6,
SK4 advertisement; and one simply said ‘‘nice.’’ 29Id. 1983).
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Federal Register/Vol. 77, No. 37/Friday, February 24, 2012/Rules and Regulations 11255
and/or NFA member. Therefore, the obligations. The Commission also company. The Commission is focused
Commission continues to believe that its recognizes that modification to §4.5 on registered investment companies
registration requirements further critical may result in costs for registered because it is aware of increased trading
regulatory objectives and serve investment companies. For that reason, activity in the derivatives area by such
important public policy goals. as stated above, in conjunction with entities that may not be appropriately
A number of commenters who finalizing the proposed amendments to addressed in the existing regulatory
expressed general opposition also §4.5, the Commission has proposed to protections, including risk management
acknowledged that if the Commission adopt a harmonized compliance regime and recordkeeping and reporting
determined to proceed with its for registered investment companies requirements. The SEC has also noted
proposed changes to §4.5, certain areas whose activities require oversight by the this increased trading activity and is
of harmonization with SEC Commission. Although the Commission reviewing the use of derivatives by
requirements should be addressed. To believes the modifications to §4.5 investment companies.35In its recent
that end, concurrently with the issuance enhance the Commission’s ability to concept release regarding the use of
of this rule, the Commission plans to effectively oversee derivatives markets, derivatives by registered investment
issue a notice of proposed rulemaking it is not the Commission’s intention to companies, the SEC noted that although
detailing its proposed modifications to burden registered investment companies its staff had addressed issues related to
part 4 of its regulations to harmonize the beyond what is required to provide the derivatives on a case-by-case basis, it
compliance obligations that apply to Commission with adequate information had not developed a ‘‘comprehensive
dually registered investment companies. it finds necessary to effectively oversee and systematic approach to derivatives
Commenters did not question, however, the registered investment company’s related issues.’’36As aptly noted by the
that the Commission has a regulatory derivatives trading activities. Through Chairman of the SEC, ‘‘The controls in
interest in overseeing entities engaging this harmonization, the Commission place to address fund management in
in derivatives trading. Rather, they intends to minimize the burden of the traditional securities can lose their
argued that the SEC currently provides amendments to §4.5. effectiveness when applied to
adequate oversight of their activities. Second, the Commission disagrees derivatives. This is particularly the case
The Commission disagrees with the with the commenters’ assertion that the because a relatively small investment in
arguments presented by those Commission would not receive any a derivative instrument can expose a
commenters who argued against the meaningful benefit from a modification fund to potentially substantial gain or
adoption of any change to §4.5. The to §4.5. As stated above, the loss—or outsized exposure to an
Commission continues to believe that Commission disagrees that such individual counterparty.’’37Despite the
entities operating collective investment registration and oversight is redundant, commenter’s assertion, the Commission
vehicles that engage in more than a de and emphasizes that it is in the best is unaware of other classes of entities
minimis amount of derivatives trading position to adequately oversee the that are excluded from the definition of
should be required to register with the derivatives trading activities of entities CPO engaging in significant derivatives
Commission. The Commission believes in which the Commission has a trading. Of course, if the Commission
that because Congress empowered the regulatory interest. As discussed above, becomes aware of any other categories
Commission to oversee the derivatives the Commission is charged with of excluded entities engaging in similar
market, the Commission is in the best administering the Commodity Exchange levels of derivatives trading, it will
position to oversee entities engaged in Act to protect market users and the consider appropriate action to ensure
more than a limited amount of non- public from fraud, manipulation, that such entities and their derivatives
hedging derivatives trading. abusive practices and systemic risk
Several commenters also asserted that related to derivatives that are subject to 35For example, the SEC recently issued a concept
modifying §4.5 would result in a the Act, and to foster open, competitive, release seeking comment on use of derivatives by
significant burden to entities required to and financially sound markets. The investment companies, noting: ‘‘The dramatic
register with the Commission without Commission’s programs are structured growth in the volume and complexity of derivatives
investments over the past two decades, and funds’
any meaningful benefit to the and its resources deployed in service of increased use of derivatives, have led the
Commission.32The Commission that mission. [Securities and Exchange] Commission and its staff
believes, as discussed throughout this One commenter questioned the to initiate a review of funds’ use of derivatives
release, that entities that are offering Commission’s reasoning for choosing to under the Investment Company Act. (footnotes
omitted)’’ 76 FR 55237, 55238 (Sep. 7, 2011).
services substantially identical to those impose additional requirements on
3676 FR 55237, 55239 (Sept. 7, 2011). See, Press
of a registered CPO should be subject to registered investment companies but not Release, Securities and Exchange Commission, SEC
substantially identical regulatory proposing to impose such requirements Seeks Public Comment on Use of Derivatives by
on other categories of entities.33This Mutual Funds and Other Investment Companies
(Aug. 31, 2011), available at http://www.sec.gov/
32See ICI Letter; comment letter from Vanguard commenter also stated that the
news/press/2011/2011-175.htm (‘‘‘The derivatives
(lAetpterri lf r1o2m, 2 R0e1e1d) (S‘‘mViatnhg LuLarPd ( ALeptrtielr ’1’)2;, c2o0m11m) e(n‘‘tR eed Commission was required to detail its markets have undergone significant changes in
Smith Letter’’); comment letter from reasoning under the Administrative recent years, and the Commission is taking this
AllianceBernstein Mutual Funds (April 12, 2011) Procedure Act.34As stated in the opportunity to seek public comment and ensure
(‘‘AllianceBernstein Letter’’); comment letter from Proposal, the Commission remains that our regulatory approach and interpretations
U20n1i1te)d (‘ S‘UtaStAesA A Luettotmero’’b);i lceo mAsmsoecnita lteiottne r( Afrpormil 12, concerned that registered investment urenldevear ntht,e a Inndv ecsotnmseisntte nCto wmiptha niny vAecstto rre mpraoitne cctuiorrne,n’’t’,
Principal Management Corporation (April 12, 2011) companies are offering managed futures said SEC Chairman Mary Shapiro.’’).
(‘‘PMC Letter’’); comment letter from Investment strategies, either in whole or in part, 37Chairman Mary Shapiro, Opening Statement at
ES2 Acodmvimseern At lsestotecri aftrioomn (DAepcrhiel r1t2 L, L2P0 1a1n)d ( ‘c‘IlAieAnt Ls e(Atteprr’i’l) ; without Commission oversight and SFEuCnd Os p(Aenu gM. e3e1t,i n20g 1It1e)m, a v1a—ilUabslee o aft Dhettrpiv:/a/t ives by
RUL 12, 2011) (‘‘Dechert II Letter’’); comment letter from without making the disclosures to both www.sec.gov/news/speech/2011/spch083111mls-
with Janus Capital Management LLC (April 12, 2011) the Commission and investors regarding item1.htm (‘‘The current derivatives review gives us
D (‘‘Janus Letter’’); comment letter from Security the pertinent facts associated with the the opportunity to re-think our approach to
N1PRO TLerattdeer’r’s) ;A csosmocmiaetniot nle (tAtepr rfirlo 1m2 ,I n2v0e1s1c)o ( ‘A‘SdTvAis ers, Inc. investment in the registered investment reenggualgaitning gi nfu tnhdiss ’r euvsiee wof wdeitrhiv aa thivoeliss.t Wic ep earrsep ective,
TV (April 12, 2011) (‘‘Invesco Letter’’); and comment in the wake of the financial crisis, and in light of
VP letter from Equinox Fund Management, LLC (July 33See ICI Letter. the new comprehensive regulatory regime for swaps
SK4 28, 2011) (‘‘Equinox Letter’’). 34Id. being developed under the Dodd-Frank Act.’’).
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11256 Federal Register/Vol. 77, No. 37/Friday, February 24, 2012/Rules and Regulations
trading activities are brought under the levels for securities product futures are hedging’’ would be modified through
Commission’s regulatory oversight. As significantly higher and the levels for future rulemakings,46which were open
stated previously, the Commission swaps margining may be as well. The for comments from the public.
continues to believe that entities that are Commission believes, however, that The Commission recently adopted
offering services substantially identical trading exceeding five percent of the final rules regarding position limits and,
to those of a registered CPO should be liquidation value of a portfolio through that rulemaking, implemented a
subject to substantially identical evidences a significant exposure to the new statutory definition of bona fide
regulatory obligations. derivatives markets. The Commission hedging transactions for exempt and
believes that such exposure should excluded commodity transactions as
2. Comments on the Proposed Trading
subject an entity to the Commission’s part of new §151.5.47This statutory
Threshold
oversight. Moreover, the Commission definition limits the scope of bona fide
The Commission also received believes that its adoption of an hedging transactions for exempt and
numerous comments on the proposed alternative net notional test to agricultural commodities, and does not
addition of a trading threshold to the determine eligibility for exclusion from provide for a risk management
exclusion under §4.5.38The proposed the definition of CPO, as discussed exemption for position limits
trading threshold provided that infra, provides flexibility to registered purposes.48With regard to position
derivatives trading could not exceed investment companies in consideration limits and bona fide hedging
five percent of the liquidation value of of the fact that initial margin for certain transactions for excluded commodities,
an entity’s portfolio, without commodity interest products may not the Commission amended the pre-Dodd-
registration with the Commission. The permit compliance with the five percent Frank definition of bona fide hedging in
Proposal excluded activity conducted threshold. §1.3(z) to only apply to excluded
for ‘‘bona fide hedging’’ purposes.39 Commenters also recommended that commodities. Further, the Commission
Most commenters stated that a five the Commission exclude from the allowed DCMs and SEFs that are trading
percent threshold was far too low in threshold calculation various facilities to provide for a risk
light of the Commission’s determination instruments including broad-based management exemption from position
to include swaps within the measured stock index futures, security futures limits for excluded commodity
activities and the limited scope of the
generally, or financial futures contracts transactions.
Commission’s bona fide hedging as a whole.42The Commission does not The Commission does not believe that
definition, but no data was provided to believe that exempting any of these it is appropriate to exclude risk
support this assertion. The Commission, instruments from the threshold management transactions from the
in its adoption of the exemption under calculation is appropriate. The trading threshold. The Commission
§4.13(a)(3),40previously determined Commission does not believe that there believes that an important distinction
that five percent is an appropriate is a meaningful distinction between between bona fide hedging transactions
threshold to determine whether an those security or financial futures and and those undertaken for risk
entity warrants oversight by the
other categories of futures. The management purposes is that bona fide
Commission.41
Commission believes that its oversight hedging transactions are unlikely to
Despite the views of some
of the use of security or financial futures present the same level of market risk as
commenters, the Commission believes
is just as essential as its oversight of they are offset by exposure in the
that the five percent threshold continues
physical commodity futures. Congress physical markets. Additionally, the
to be the appropriate percentage for
granted the Commission authority over Commission is concerned that in the
exemption or exclusion based upon an
all futures in §2 of the CEA.43The context of exclusion under §4.5, a risk
entity’s limited derivatives trading. Five
Commission believes that it is in the management exclusion would permit
percent remains the average required for
best position to assess investor and registered investment companies to
futures margins, although the
market risks posed by entities trading in engage in a greater volume of
Commission acknowledges that margin
derivatives regardless of type. Therefore, derivatives trading than other entities
the Commission has decided not to which are engaged in similar activities,
38See Invesco Letter; ICI Letter; Vanguard Letter;
Reed Smith Letter; AllianceBernstein Letter; AII modify the scope of the threshold from but which are otherwise required to
Letter; STA Letter; Janus Letter; PMC Letter; USAA what was proposed in order to exclude register as CPOs. This could result in
Letter; comment letter from Fidelity Management security futures or financial futures from disparate treatment among similarly
and Research Co. (April 12, 2011) (‘‘Fidelity the trading threshold. situated entities. Moreover, there was no
Letter’’); comment letter from Securities Industry
and Financial Markets Association (April 12, 2011) Commenters requested that the consensus among the commenters as to
(‘‘SIFMA Letter’’); comment letter from Dechert LLP Commission expand its definition of the appropriate definition of risk
(July 26, 2011) (‘‘Dechert III Letter’’); comment letter bona fide hedging as it appears in management transactions. Thus, the
from Rydex/SGI Morgan, Lewis & Bockius LLP §1.3(z) to include risk management as a Commission believes that it may be
(April 12, 2011) (‘‘Rydex Letter’’); comment letter
from the United States Chamber of Commerce recognized bona fide hedging activity difficult in this context to properly limit
(April 12, 2011) (‘‘USCC Letter’’); comment letter for purposes of §4.5.44The Proposal the scope of such exclusion as objective
from Sidley Austin LLP (April 12, 2011) (‘‘Sidley excluded activity conducted for ‘‘bona criteria are not universally recognized,
Letter’’); comment letter from the National Futures fide hedging’’ purposes as that term was which would make such exclusion
Association (April 12, 2011) (‘‘NFA Letter’’);
comment letter from Campbell & Company, Inc. defined in §1.3 as it existed at the time onerous to enforce.49
(April 12, 2011) (‘‘Campbell Letter’’); comment of the proposal.45Further, the Proposal
letter from AQR Capital Management, LLC (April noted that the Commission anticipated 4676 FR 7976, 7984 (Feb. 11, 2011).
ES2 12, 2011) (‘‘AQR Letter’’); comment letter from that the definition of ‘‘bona fide 477 U.S.C. 6a(c); 76 FR 71626, 71643 (Nov. 18,
UL Steben & Company, Inc. (April 12, 2011) (‘‘Steben 2011).
D with R LCeotmtepr’a’)n; yc oInmsmtiteuntet l(eJuttleyr 2fr8o,m 20 t1h1e) I(n‘‘vICesIt ImI Lenettt er’’); 42See Rydex Letter; Invesco Letter; ICI Letter. 44897T6h eF RC o7m16m2i6s,s 7io1n6 4n4o t(eNso tvh.a 1t 8§, 42.051 r1e)f.e rences the
RO and comment from the Association of Institutional 437 U.S.C. 2. definition of bona fide hedging for exempt and
TVN1P Inv39es7t6o rFsR ( A79p7ri6l, 1729,8 290 (1F1e)b (.‘ ‘1A1I,I 2L0e1tt1e)r.’ ’). Re4e4dS Seem Iinthv eLsectote Lr;e tAtellri;a InCcIe LBeetrtners;t eViann Lgeutaterdr; LIAetAte r; athgeri dcueflitnuirtailo cno omf mboondai tfiiedse u hneddegri n§g1 5fo1r. 5e xacs lwudeelld a s
VP 4017 CFR 4.13(a)(3). Letter; Janus Letter; and STA Letter. commodities under §1.3(z). Market participants
SK4 4168 FR 47221, 47225 (Aug. 8, 2003). 4576 FR 7976, 7989 (Feb. 11, 2011). should not construe either §151.5 or §1.3(z) as
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Federal Register/Vol. 77, No. 37/Friday, February 24, 2012/Rules and Regulations 11257
During numerous meetings with the use of an index or other passive Commission would remove the trading
commenters, the commenters noted that investment vehicle by a large number of restrictions from §4.5 as well to provide
most registered investment companies investment companies can amplify the consistent treatment.61
use derivatives for risk management market assumptions built into an index The Commission no longer believes
purposes, namely to offset the risk or other vehicle. Thus, the Commission that its prior justification for
inherent in positions taken in the has decided not to adopt the panelist’s abandoning the alternative net notional
securities or bond markets, or to suggestion that the Commission focus test is persuasive. By the adoption of
equitize cash efficiently. Although the on whether an entity offers an actively this final rule, the Commission will
Commission recognizes the importance managed futures strategy. reinstate the five percent trading
of the use of derivatives for risk One commenter suggested that the threshold in §4.5 for registered
management purposes, it does not Commission should consider the investment companies and rescind the
believe that transactions that are not adoption of an alternative test that exemption in §4.13(a)(4), which
within the bona fide hedging definition would be identical to the aggregate net reverses the regulatory conditions in
should be excluded from the notional value test that is currently existence in 2003. The Commission
determination of whether an entity available under §4.13(a)(3)(ii)(B).53 believes that the appropriate criteria for
meets the trading threshold for Section 4.13(a)(3)(ii)(B) provides that an exclusion through the use of a net
registration and oversight. Therefore, entity can claim exemption from notional test is delineated in
the Commission has decided not to registration if the net notional value of §4.13(a)(3)(ii)(B),62commonly known
exclude risk management activities by its fund’s derivatives trading does not as the ‘‘de minimis exemption,’’ albeit
registered investment companies from exceed one hundred percent of the with the addition of allowing unlimited
the trading threshold for purposes of liquidation value of the fund’s use of futures, options, or swaps for
§4.5. portfolio.54 bona fide hedging purposes, which is
Several panelists at the Commission’s Conversely, several panelists at the not permitted under §4.13(a)(3).
staff roundtable held on July 6, 201150 Roundtable opposed such a test, stating As stated previously, the net notional
(‘‘Roundtable’’) suggested that, instead that it was not a reliable means to test, as set forth under §4.13(a)(3)(ii)(B),
of a trading threshold that is based on measure an entity’s exposure in the permits entities to claim relief if the
a percentage of margin, the Commission market.55Specifically, certain panelists aggregate net notional value of the
should focus solely on entities that offer asserted that the net notional value of entity’s commodity interest positions
‘‘actively managed futures’’ strategies.51 positions may not provide a reliable does not exceed 100 percent of the
The panelist defined ‘‘actively managed measure of the risk posed by certain liquidation value of the pool’s
futures’’ strategies as those in which the entities in the market.56 portfolio.63Notional value is defined by
entity or its investment adviser made its The Commission first considered the asset class. For example, the notional
own decisions as to which derivatives to addition of an alternative net notional value of futures contracts is derived by
take positions in, as compared to the trading threshold when it proposed to multiplying the number of contracts by
‘‘passive’’ use of an index, wherein the amend §4.5 in 2002.57In support of its
the size of the contract, in contract
entity’s investments simply track those proposal, the Commission stated that
units, and then multiplying by the
held by an index.52 the alternative test provided otherwise
current market price for the contract.64
The Commission does not believe that regulated entities that use certain
The notional value of a cleared swap,
it is proper to exclude from the classes of futures with higher initial
however, will be determined consistent
Commission’s oversight those entities margin requirements with an
with the provisions of part 45 of the
that are using an index or other so- opportunity to also receive exclusionary
Commission’s regulations. The ability to
called ‘‘passive’’ means to track the relief from the definition of CPO.58The
net positions is also determined by asset
value of other derivatives. Establishing Commission further stated that the
class, with entities being able to net
‘‘active’’ versus ‘‘passive’’ use of inclusion of an alternative test enabled
futures contracts across designated
derivatives as a criterion for entitlement entities seeking exclusion to rely on
contract markets or foreign boards of
to the exclusion would introduce an whichever test was less restrictive based
trade, whereas swaps may only be
element of subjectivity to an otherwise on their futures positions.59In 2003, the
netted if cleared by the same designated
objective standard and make the Commission proposed and adopted final
clearing organization (‘‘DCO’’) and it is
threshold more difficult to interpret, rules amending §4.5, which eliminated
otherwise appropriate.65
apply, and enforce. It also could have the five percent trading threshold and
The Commission believes that the
the undesirable effect of encouraging did not adopt the alternative net
adoption of an alternative net notional
funds to structure their investment notional test.60In stating its rationale for
test will provide consistent standards
activities to avoid regulation. Moreover, rescinding the five percent threshold
for relief from registration as a CPO for
test and declining to adopt the
entities whose portfolios only contain a
permitting a risk management exemption for alternative net notional test, the
purposes of determining compliance with the Commission stated that because it was
trading threshold in §4.5. simultaneously proposing, and 6168 FR 12622, 12625–26 (noting that although
50See Notice of CFTC Staff Roundtable ultimately adopting, an exemption from entities excluded under §4.5 could solicit retail
Discussion on Proposed Changes to Registration participants, as compared to those entities exempt
and Compliance Regime for Commodity Pool registration in §4.13(a)(4), which did under §4.13(a)(4), which may only offer to certain
Operators and Commodity Trading Advisors, not impose any trading restriction, the high net worth entities and individuals, the
available at http://www.cftc.gov/PressRoom/Events/ Commission stated that the fact that the §4.5
opaevent_cftcstaff070611. entities were otherwise regulated supported
ULES2 Di5s1cuSsesei oTnra onns cPrrioppt oosf eCdF CThCa Sntgaefsf tRoo Ruengditsatbraleti on 5534D17e cChFeRrt 4II.1I 3L(eat)t(e3r).( ii)(B). co6n2sTishteen nt ectr nitoetriioan faolr treeslti eafs) .i t appears in
D with R aOnpde rCaotomrsp lainadn cCeo Rmemgimodei tfyo rT Craodminmgo Additvyi sPoorosl 5556SSeeee RRoouunnddttaabbllee TTrraannssccrriipptt aatt 6790–. 71. §pr4o.1v3id(ae) (g3u)i dwainllc bee r eagmaerdnidnegd t hbye athbiisli rtyu lteom naekti ng to
RO (‘‘Roundtable Transcript’’), at 19, 25, 30, 76–77, 87– 5767 FR 65743 (Oct. 28, 2002). cleared swaps.
N1P 90, available at http://www.cftc.gov/ucm/groups/ 5867 FR 65743, 65744–45. 6317 CFR 4.13(a)(3)(ii)(B).
V public/@swaps/documents/dfsubmission/ 5967 FR 65743, 65745. 64Id.
T
VP dfsubmission27_070611-trans.pdf. 6068 FR 12622 (Mar. 17, 2003); 68 FR 47221 65See discussion of amendments to
SK4 52Id. (Aug. 8, 2003). §4.13(a)(3)(ii)(B) infra.
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11258 Federal Register/Vol. 77, No. 37/Friday, February 24, 2012/Rules and Regulations
limited amount of derivatives positions Several commenters expressed concern Commission, it must do so explicitly in
and will afford registered investment that the Commission would require the exclusion.72Because the
companies with additional flexibility in inclusion of swaps within the threshold Commission has determined that de
determining eligibility for exclusion. prior to its adoption of final rules minimis activity by registered
Therefore, the Commission will adopt further defining the term ‘‘swap’’ and investment companies does not
an alternative net notional test, explaining the margining requirements implicate the Commission’s regulatory
consistent with that set forth in for such instruments. The Commission concerns, the Commission has decided
§4.13(a)(3)(ii)(B) as amended herein, for agrees that it should not implement the to include swaps as a component of the
registered investment companies inclusion of swaps within the threshold trading threshold.
claiming exclusion from the definition test prior to the effective date of such
4. Comments on the Proposed Marketing
of CPO under §4.5. final rules. Therefore, it is the
Restriction
The Commission also received several Commission’s intention to establish the
comments supporting both the compliance date of the inclusion of The marketing restriction, as
imposition of a trading threshold in swaps within the threshold calculation proposed by the Commission, prohibits
general and the five percent threshold as 60 days after the final rules regarding the marketing of interests in the
specifically.66At least one commenter the definition of ‘‘swap’’ and the registered investment company ‘‘as a
suggested, however, that the delineation of the margin requirement vehicle for trading in (or otherwise
Commission consider requiring for such instruments are effective.69The seeking investment exposure to) the
registered investment companies that Commission believes that such commodity futures, commodity options,
exceed the threshold to register, but not compliance date will provide entities or swaps markets.’’73Again, as with the
subjecting them to the Commission’s with sufficient time to assess the impact other aspects of the proposed
compliance regime beyond requiring of such rules on their portfolios and to amendments to §4.5, the Commission
them to be subject to the examination of make the determination as to whether received numerous comments on this
their books and records, and registration with the Commission is prohibition.74
examination by the National Futures required. The vast majority of comments urged
Association.67In effect, this commenter The Commission also received a the Commission to remove the clause
requested that the Commission subject comment asking for additional ‘‘or otherwise seeking investment
such registrant to ‘‘notice registration.’’ clarification regarding its decision to exposure to’’ as introducing an
The Commission believes that adopting include swaps within the threshold.70 unacceptable level of ambiguity into the
the commenter’s approach would not The Dodd-Frank Act amended the marketing restriction.75The
materially change the information that statutory definition of the terms Commission agrees with these
the Commission would receive ‘‘commodity pool operator’’ and comments and believes that the removal
regarding the activities of registered ‘‘commodity pool’’ to include those of this clause is appropriate as the
investment companies in the derivatives entities that trade swaps.71If the clause does not meaningfully add to the
markets, which is one of the Commission were to adopt the trading marketing restriction and only creates
Commission’s purposes in amending threshold and only include futures and uncertainty. Thus, the Commission will
§4.5. Moreover, a type of notice options as the basis for calculating adopt the marketing restriction without
registration would not provide the compliance with the threshold, the the clause ‘‘or otherwise seeking
Commission with any real means for swaps activities of the registered investment exposure to * * *’’
engaging in consistent ongoing investment companies would still The Commission also received many
oversight. Notwithstanding such notice trigger the registration requirement comments asking that the Commission
registration, the Commission would still notwithstanding the exclusion of swaps provide some clarification regarding the
be deemed to have regulatory from the calculus. That is, the purpose factors that it would consider in making
responsibility for the activities of these of the threshold test is to define a de the determination whether an entity
registrants. In the Commission’s view, minimis amount of trading activity that violated the marketing restriction.76The
notice registration does not equate to an would not trigger the registration Commission agrees that providing
appropriate level of oversight. For that requirement. If swaps were excluded, factors to further explain the plain
reason, the Commission has determined any swaps activities undertaken by a language of the marketing restriction
not to adopt the notice registration registered investment company would would be helpful to those who plan to
system proposed by the commenter. The result in that entity being required to market registered investment companies
Commission is adopting the amendment register because there would be no de
to §4.5 regarding the trading threshold minimis exclusion. As a result, one 72Any reference to a de minimis level of swaps
with the addition of an alternative net swap contract would be enough to activities by registered investment companies only
applies in the context of CPO registration by
notional test for the reasons stated trigger the registration requirement. For
registered investment companies.
herein and those previously discussed that reason, if the Commission wants to 7376 FR 7976, 7989 (Feb. 12, 2011).
in the Proposal. permit some de minimis level of swaps 74See Rydex Letter; Fidelity Letter; SIFMA Letter;
activity by registered investment AII Letter; ICI Letter; Vanguard Letter; Reed Smith
3. Comments on the Inclusion of Swaps companies without registration with the Letter; AllianceBernstein Letter; USAA Letter; PMC
in the Trading Threshold Letter; Invesco Letter; Janus Letter; STA Letter;
comment letter from the Managed Futures
The Commission also received PMC Letter; Invesco Letter; IAA Letter; Dechert II Association regarding proposed amendments to
numerous comments opposing its Letter; AII Letter; and SIFMA Letter. §4.5 (April 12, 2011) (‘‘MFA II Letter’’); Dechert II
ES2 decision to include swaps within the 69Effective Date for Swap Regulation, 76 FR Letter; NFA Letter; comment letter from Alston &
RUL threshold test discussed above.68 42508 (issued and made effective by the Bird, LLP (April 12, 2011) (‘‘Alston Letter’’);
D with CRoegmismteirs soionn J uolny J1u9l,y 2 1041,1 2)0. 11; published in Federal CDaemchpebrte lIlI IL Leettteter;r .A QR Letter; Steben Letter; and
RO 66See NFA Letter, Campbell Letter, AQR Letter, 70See Janus Letter; Reed Smith Letter; 75See, e.g., ICI Letter; Alston Letter; Rydex Letter;
N1P Steben Letter. AllianceBernstein Letter; USAA Letter; ICI Letter; and Vanguard Letter.
TV 67See AQR Letter. PMC Letter; Invesco Letter; IAA Letter; Dechert II 76See ICI Letter; MFA II Letter; Dechert II Letter;
VP 68See Janus Letter; Reed Smith Letter; Letter; AII Letter; and SIFMA Letter. Invesco Letter; NFA Letter; Campbell Letter; Steben
SK4 AllianceBernstein Letter; USAA Letter; ICI Letter; 717 U.S.C. 1a(10); 1a(11). Letter; and AQR Letter.
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Federal Register/Vol. 77, No. 37/Friday, February 24, 2012/Rules and Regulations 11259
to investors. The Commission has the terms ‘‘futures’’ or ‘‘derivatives,’’ or Commission’s compliance regime with
determined, however, that such factors otherwise indicates a possible focus on that of the SEC. Upon consideration of
should be instructive and that no single futures or derivatives, will not be the comments and the discussions held
factor is dispositive. The Commission considered a dispositive factor, but as a result of the Roundtable relating to
will determine whether a violation of rather one of many that the Commission registered investment companies that
the marketing restriction exists on a case will consider in making its will be required to register under
by case basis through an examination of determination. Moreover, the amended §4.5, the Commission agrees
the relevant facts. The Commission Commission will not consider the mere that it is necessary to harmonize the
seeks to discourage entities from disclosure to investors or potential
Commission’s compliance obligations
designing creative marketing with the investors that the registered investment
under part 4 of the Commission’s
intent to avoid the marketing restriction. company may engage in derivatives
regulations with the requirements of the
To address commenters’ requests for trading incidental to its main
SEC for registered investment
guidance, the Commission believes that investment strategy and the risks
companies. To that end, concurrently
the following factors are indicative of associated therewith as being violative
with the issuance of this rule, the
marketing a registered investment of the marketing restriction.
company as a vehicle for investing in At the Roundtable, several panelists Commission is issuing a notice of
commodity futures, commodity options, questioned the Commission’s reasoning proposed rulemaking detailing its
or swaps: for deeming the use of a controlled proposed modifications to part 4 of its
• The name of the fund; foreign corporation (‘‘CFC’’) to be an regulations to harmonize the
• Whether the fund’s primary appropriate factor in determining compliance obligations that apply to
investment objective is tied to a whether the registered investment dually registered investment companies.
commodity index; company violates the marketing The Commission will not require
• Whether the fund makes use of a restriction. Based on comments received entities that must register due to the
controlled foreign corporation for its at the Roundtable and during the amendments to §4.5 to comply with the
derivatives trading; comment period, the Commission Commission’s compliance regime until
• Whether the fund’s marketing believes that registered investment the adoption of final rules governing the
materials, including its prospectus or companies use controlled foreign compliance framework for registered
disclosure document, refer to the corporations as a mechanism to invest investment companies subject to the
benefits of the use of derivatives in a up to 25 percent of the registered Commission’s jurisdiction.
portfolio or make comparisons to a investment company’s portfolio in
derivatives index; derivatives.78The Commission, 6. Comments Regarding the Entity
• Whether, during the course of its therefore, believes that a registered Required to Register as the CPO
normal trading activities, the fund or investment company’s use of a CFC may
entity on its behalf has a net short indicate that the company is engaging in The Commission received a number
speculative exposure to any commodity derivatives trading in excess of the of comments requesting clarification as
through a direct or indirect investment trading threshold. Again, the to which entity would be required to
in other derivatives; Commission will consider this factor in register as a CPO if a registered
• Whether the futures/options/swaps the context of the registered investment investment company would not qualify
transactions engaged in by the fund or company’s other conduct and will not for exclusion under §4.5, as amended.80
on behalf of the fund will directly or view this factor as being dispositive of The commenters consistently proposed
indirectly be its primary source of a violation of the marketing restriction. that the registered investment
potential gains and losses; and For these reasons, and those stated in company’s investment adviser is the
• Whether the fund is explicitly the Proposal, the Commission adopts appropriate entity to register in the
offering a managed futures strategy.77 the marketing restriction in §4.5 with capacity of the investment company’s
The Commission will give more the modifications discussed herein. CPO. The Commission agrees that the
weight to the final factor in the list
investment adviser is the most logical
when determining whether a registered 5. Comments on the Harmonization of
investment company is operating as a de Compliance Obligations entity to serve as the registered
investment company’s CPO. To require
facto commodity pool. In contrast, a Many commenters raised concerns
a member or members of the registered
registered investment company that about the potential conflicts between
investment company’s board of
does not explicitly offer a managed the Commission’s regulatory regime and
directors to register would raise
futures strategy could still be found to that imposed by the SEC if the
operational concerns for the registered
have violated the marketing restriction Commission were to adopt the proposed
investment company as it would result
based on whether its conduct satisfied amendments as final rules.79As noted
any number of the other factors above, in an effort to obtain further in piercing the limitation on liability for
enumerated above. Put differently, if a information from interested parties, actions undertaken in the capacity of
registered investment company offers a Commission staff held the Roundtable, director.81Thus, the Commission
strategy with several indicia of a and invited staff from the SEC, the IRS, concludes that the investment adviser
managed futures strategy, yet avoids and members of various trade for the registered investment company
explicitly describing the strategy as such organizations. The roundtable focused is the entity required to register as the
in its offering materials, that registered predominantly on harmonization of the CPO.
S2 investment company may still be found
E
UL to have violated the marketing 78See Roundtable Transcript at 152–53. 80See ICI Letter; Reed Smith Letter;
R
D with resTtrhiec tCioonm. mission also notes that Le7t9teSre; eR eVeadn gSumairtdh LLeetttteerr;; IAClIl LiaenttceerB; eDrencshteeirnt ILIIe tter; ALelltitaenr;c UeBSeArAns Lteeitnte Lr;e PttMerC; R Lyedtteexr ;L IeAttAer L; eFtitdeer;l iJtayn us
N1PRO whether the name of the fund includes ULeStAteAr; DLeetcthere;r Pt IMI LCe Ltteetrt;e Fr;i dInevlietsyc Lo eLtteetrte; rJ;a nIAuAs Lfreotmte rA; SlpIFhMaSAim Lpeltetexr G; SroTuAp L(Aetpterri;l c1o2m, 2m0e1n1t) l(e‘‘tAteSrG
TV Letter; SIFMA Letter; STA Letter; AQR Letter; NFA Letter’’); NFA Letter; MFDF Letter; and Campbell
VP 77These factors are derived in substantial part Letter; MFA II Letter; Alston Letter; Rydex Letter; Letter.
SK4 from the Steben Letter and AQR Letter. and ICI II Letter. 81See MFDF Letter.
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11260 Federal Register/Vol. 77, No. 37/Friday, February 24, 2012/Rules and Regulations
7. Comments Regarding the Use of futures product, or swap.’’85Based on a the ongoing efforts to further define the
Controlled Foreign Corporations plain language reading of the statutory term ‘‘swap’’ and the margin
definition, CFCs wholly owned by requirements for swaps positions, the
The Commission received many
registered investment companies and Commission recognizes that a short
comments regarding the use of CFCs by
used for trading commodity interests are implementation period is not
registered investment companies for
properly considered commodity pools. practicable. The Commission believes
purposes of engaging in commodities
trading. As stated previously, it is the These entities also satisfy the definition that 11 months is an adequate amount
Commission’s understanding that of ‘‘pool’’ delineated in §4.10(d)(1) of of time to enable compliance by existing
registered investment companies invest the Commission’s regulations, which is registered investment companies.
up to 25 percent of their assets in the substantively identical to the statutory Recognizing that the definition of swap
CFC, which then engages in actively definition. There is no meaningful basis is not yet finalized, the Commission has
for concluding otherwise. Moreover, the
managed derivatives strategies, either on decided that compliance with the
Commission believes that each separate
its own or under the direction of one or amendments to §4.5 for purposes of
legally cognizable entity must be
more CTAs. Operators of CFCs have registration only will occur on the later
assessed on its own characteristics and
been exempt from Commission of either December 31, 2012 or within
that a CFC should not be entitled to
registration by claiming relief under 60-days following the adoption of final
exclusion simply because its parent
§4.13(a)(4) of the Commission’s rules defining the term ‘‘swap,’’ and
company is a registered investment
regulations because the sole participant establishing margin requirements for
company that may be entitled to
in the CFC is the registered investment such instruments.91Entities required to
exclusion under §4.5. Therefore, the
company. Additionally, at the register due to the amendments to §4.5
Commission does not oppose the use of
Roundtable, panelists informed shall be subject to the Commission’s
CFCs for trading in commodity interests
Commission staff that several registered recordkeeping, reporting, and disclosure
by registered investment companies, but
investment companies that operated requirements set forth in part 4 of the
such CFCs will be required to have their
CFCs did not claim relief under Commission’s regulations within 60
CPOs register with the Commission
§4.13(a)(4) because it was their opinion days following the effectiveness of a
unless they may claim exemption or
that the CFC was merely a subdivision exclusion therefrom on their own final rule implementing the
of the registered investment company merits. Commission’s proposed harmonization
and was not a separate commodity effort pursuant to the concurrent
pool.82 8. Comments Regarding Implementation proposed rulemaking.
Commenters urged the Commission to of Amendments
Several commenters also suggested
continue to permit registered The Commission received several that the Commission exempt from
investment companies to use CFCs and comments with suggestions regarding
compliance those registered investment
to allow such CFCs to be exempt from implementation of the proposed
companies that have already claimed
registration with the Commission under amendments to §4.5, if the Commission
relief under §4.5.92The Commission
§4.13 or exclude them under §4.5 by decided to adopt the proposed
does not believe that ‘‘grandfathering’’ is
reason of their sole investor being provisions as final rules.86Several
appropriate in this context. As the
excluded as well. Commenters proposed commenters recommended that the
Commission stated in its Proposal, and
various mechanisms by which the Commission provide for an undefined
reaffirms in this preamble, part of the
Commission could obtain information ‘‘substantial transition period for
purpose of amending §4.5 is to ensure
regarding the activities of CFCs, compliance.’’87Conversely, one
that entities that are engaged in a certain
including requiring disclosure of CFC commenter suggested that the
level of derivatives trading are subject to
fees and expenses at the registered Commission should only provide a
the registration and compliance
investment company level, requiring a short period of time for compliance.88
obligations and oversight by the
representation that the CFC will comply Another commenter suggested that at
Commission.93Grandfathering is
with key provisions of the Investment least 12-months would be required for
inconsistent with the goals of the
Company Act of 1940 (‘‘Investment registered investment companies to
Commission’s amendments. The
Company Act’’),83and requiring the come into registration and compliance
Commission, however, believes that
registered investment company to make with Commission requirements.89
harmonization of the Commission’s
its CFC’s books and records available to Finally, a commenter suggested that the
compliance regime with that of the SEC
the Commission and NFA for Commission delay implementation until
will minimize the regulatory burden of
inspection. all mandatory Dodd-Frank Act rules are
existing registered investment
The Commission does not oppose the implemented.90
continued use of CFCs by registered In light of the Commission’s proposed companies. In addition, the Commission
investment companies, but it believes harmonization effort with respect to the is permitting a sufficient amount of time
that CFCs that fall within the statutory compliance obligations for dually for existing entities to come into
definition of ‘‘commodity pool’’ should registered investment companies and compliance before the compliance dates
set forth above. Therefore, the
be subject to regulation as a commodity
pool.84The Dodd-Frank Act amended 857 U.S.C. 1a(10). Commission believes that it is
the CEA to define a commodity pool as 86See Steben Letter; ICI Letter; NFA Letter; Reed addressing the commenters’ concerns
Smith Letter; AllianceBernstein Letter; USAA through harmonization while still
‘‘any investment trust, syndicate, or
Letter; PMC Letter; IAA Letter; Janus Letter; STA
ensuring that the Commission has the
S2 similar form of enterprise operated for Letter; Rydex Letter; Alston Letter; and comment
E
UL the purpose of trading in commodity letter from the Association of Institutional Investors
D with R icnotmermesotds,i tiyn cfolur dfuintug raen dye *liv*er*y , security (Ju8l7yS 1e,e 2 I0C1I1 L) e(t‘t‘AerI;I NIIF LAe tLteert’t’e)r. ; Reed Smith Letter; 429510E8f.f ective Date for Swap Regulation, 76 FR
RO AllianceBernstein Letter; USAA Letter; PMC Letter; 92See ICI Letter; Reed Smith Letter;
VN1P 82See Roundtable Transcript at 165. IA8A8 SLeeett Sert;e bJaennu Ls eLtteetrte. r; and STA Letter. AJalnliuasn LceetBteerr;n AstIeIi nL eLtteetrte; rS; IIFnMveAs cLoe Ltteetrt;e arn; IdA SAT LAe tter;
T
VP 8315 U.S.C. 80a–1, et seq. 89See Rydex Letter. Letter.
SK4 847 U.S.C. 1a(10). 90See AII II Letter. 9376 FR 7976, 7983–84 (Feb. 12, 2011).
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