CFTC Issues COVID-19 Customer Advisory on Commodity ETPs and Funds

On May 28, the Commodity Futures Trading Commission (CFTC) held an open meeting to consider staff recommendations regarding amendments to two CFTC regulations. Both recommendations were approved by a unanimous 5-0 vote. Neither staff document is currently available.

Exemption from registration for certain non-US pool operators. The CFTC approved for publication a proposal to amend Regulation 3.10(c)(3) to provide an exemption from registration for foreign persons acting as commodity pool operators (CPOs) on behalf of offshore commodity pools with non-US participants that trade in US derivatives markets. The proposed amendments are designed to provide regulatory flexibility for non-US CPOs operating offshore commodity pools by taking into account the global nature of their operations without compromising the CFTC’s mission of protecting US pool participants.

Under the proposal, the exemption would be available to a foreign entity, even if that entity also operates other commodity pools with US participants for which the entity would be required to be registered as a CPO. The amendment would also permit certain US control affiliates of a non-US CPO to contribute capital to the CPO’s offshore pools as seed money without affecting the non-US CPO’s eligibility for the 3.10(c) exemption.

Recognizing that a pool operator may not always have the ability to assure that a particular pool has only non-US participants, the CFTC has also proposed a safe-harbor, pursuant to which a non-US CPO may claim an exemption under proposed Regulation 3.10(c)(3) provided the non-US CPO takes reasonable steps designed to ensure that participation units in the operated offshore pool are not being offered or sold to persons located in the United States. Specifically:

• the offshore pool’s offering materials and any underwriting or distribution agreements include must clear, written prohibitions on the offshore pool’s offering to participants located in the US and on US ownership of the offshore pool’s participation units;

• the offshore pool’s constitutional documents and offering materials: (1) must be reasonably designed to preclude persons located in the US from participating therein; and (2) include mechanisms reasonably designed to enable the CPO to exclude any persons located in the US who attempt to participate in the offshore pool notwithstanding those prohibitions;

• the non-US CPO must use non-US intermediaries exclusively for the distribution of participations in the offshore pool;

• the non-US CPO must use reasonable investor due diligence methods at the time of sale to preclude persons located in the US from participating in the offshore pool; and

• the offshore pool’s participation units must be directed and distributed to participants outside the US, including by means of listing and trading such units on secondary markets organized and operated outside of the US, and in which the non-US CPO has reasonably determined participation by persons located in the US is unlikely.

Comments on the proposed amendments must be filed with the CFTC within 60 days following publication in the Federal Register.

Extension of Phase 5 compliance schedule. In response to the COVID-19 pandemic, and following the lead of the Basel Committee on Banking Supervision (BCBS) and the International Organization of Securities Commissions (IOSCO), the CFTC approved an interim final rule amending Regulation 23.161 to extend by one year, until September 1, 2021, the initial swap margin compliance deadline for Phase 5 financial entities that was set for September 1, 2020 by a CFTC rule that just became effective on May 11. Currently, Phase 5 entities are (1) covered swap entities (CSEs) (i.e., swap dealers and major swap participants for which there is no prudential regulator, combined with their margin affiliates); and (2) their counterparties combined with their respective margin affiliates, that have a daily average aggregate notional amount (AANA) of uncleared swaps, uncleared security-based swaps, foreign exchange forwards and foreign exchange swaps in March, April and May of 2020 that exceeds $50 billion. The interim final rule defers both the measurement period and the compliance date for Phase 5 entities so that an entity with AANA exceeding $50 billion for March, April and May of 2021 must comply with the initial margin rules staring on September 1, 2021.

The CFTC, however, declined at this time to take the other action recommended by BCBS and IOSCO, namely a similar one-year deferral of the initial margin compliance date for all remaining CSEs and their counterparties (i.e., those CSEs and their counterparties with AANA of $50 billion or less (the “Phase 6” entities)). As a result, Phase 5 and Phase 6 entities will, at least temporarily, have the same compliance date of September 1, 2021. However, the CFTC noted that it intends to address deferral of the Phase 6 compliance date through a notice of proposed rulemaking and public comment process.

The interim final rule will take effect upon publication in the Federal Register. Comments on the interim final rule must be filed with the CFTC within 60 days following publication in the Federal Register.

More information and links to the Voting Drafts of each of the approved rules are available here.

CFTC Issues COVID-19 Customer Advisory on Commodity ETPs and Funds

On May 22, the Commodity Futures Trading Commission issued a Customer Advisory addressing the unique risks associated with certain trading vehicles that use futures contracts or other commodity interests. The CFTC noted that recent market volatility arising from the COVID-19 pandemic has led many investors to purchase shares of trading vehicles that use futures contracts or other commodity interests. It cautioned that, while certain trading vehicles using futures contracts or other commodity interests may be organized as exchange-traded products or mutual funds, they may not behave like traditional exchange-traded funds or mutual funds that invest in stocks, bonds or other asset classes, nor provide investors the opportunity to profit from long-term price gains in the underlying commodity.

The Customer Advisory is available here.