Impact of Proposed Amendments to CFTC Regulation 4.7 on CPOs and CTAs –

The US Commodities Futures Trading Commission (CFTC) recently proposed new rules that, among other actions, update the definition of a “qualified eligible person,” add minimum disclosure requirements for certain pools and trading programs, and permit monthly account statements for “fund of funds” to be delivered within 45 days instead of 30.

Commodity pool operators (CPOs) and commodity trading advisors (CTAs) that are unable to avail themselves of an exemption under CFTC Regulation 4.7 are subject to onerous disclosure, reporting, and recordkeeping requirements. The Regulation 4.7 exemption can be claimed by CPOs and CTAs that offer their pools or trading programs to investors who are considered “qualified eligible persons” (QEPs).

BACKGROUND

The standard for determining whether an investor is a QEP is based on the investor satisfying investor status criteria enumerated in the regulation and/or satisfying a “Portfolio Requirement,” which has remained constant since the regulation’s introduction in 1992.

The Portfolio Requirement includes two thresholds that investors may satisfy separately or by meeting a combination of the two—owning securities with an aggregate market value of at least $2 million and having at least $200,000 in exchange-specified initial margin and option premiums, together with any retail forex security deposits, on deposit with a futures commission merchant (FCM) for its own account at any time during the prior six months before investing in a 4.7 pool or opening a 4.7 account.

The CFTC’s proposed rulemaking (the Proposal) would

• double the Portfolio Requirement threshold (i.e., require investors to own $4 million in securities or have on deposit with an FCM for its own account at least $400,000 in initial margin, option premiums, or retail forex security deposits, or satisfy a combination of these two requirements);
• require CPOs and CTAs relying on Regulation 4.7 to provide uniform disclosures to QEPs;
• codify routinely issued exemptive letters allowing CPOs of fund of funds operated pursuant to Regulation 4.7 to choose to distribute monthly account statements within 45 days of the month end; and
• make other technical amendments to Regulation 4.7.

The CFTC’s proposed amendments are based on information from a 2014 staff roundtable on CPO risk management practices that led the CFTC to conclude that natural persons who satisfy the QEP definition “likely lack the ability” to request more disclosure and transparency regarding their investments in 4.7 pools or accounts.

The CFTC also explains that the Proposal is necessary because commodity interest markets have become more complex now that swaps are part of the CFTC’s jurisdiction and because of accelerated product innovation.

Comments on the Proposal are due by December 11, 2023.

PROPOSED DISCLOSURE REQUIREMENTS

Proposed QEP Disclosure Requirements for CPOs

The CFTC has proposed that CPOs of 4.7 pools provide “QEP Disclosures” that are tailored to include “the most meaningful and important information for prospective QEP pool participants.”  Essentially, the Proposal would require CPOs of 4.7 pools to provide substantially the same type and level of disclosures as CPOs of non-4.7 exempt pools with certain exceptions.

While it is commonplace for CPOs of 4.7 pools to include in the pools’ private placement memoranda (PPMs) some of the proposed QEP Disclosures—such as descriptions of risk factors, a pool’s investment objective, fees and expenses, conflicts of interest, use of proceeds, and identification of the custodian—many of the new QEP Disclosures are broader than what a CPO of a 4.7 pool would generally include in a PPM or are entirely new, such as the requirement to include a pool’s break-even point and past performance.

Break-Even Point

The Proposal would require a CPO to incorporate in a pool’s PPM the pool’s break-even point: that is, the trading profit that a pool must realize in the first year of a participant’s investment to equal fees and expenses such that the participant will recoup its initial investment, expressed both as a dollar amount and as a percentage of the minimum unit of initial investment and assuming redemption after the first year. The break-even point must be presented in a table format and be calculated consistent with CFTC and National Futures Association (NFA) requirements.

Past Performance

The Proposal would also require a CPO to include performance data in a pool’s PPM (only for the offered pool). Past performance data includes the rate of return for the pool annually for the five most recent calendar years and year to date, with monthly rates of…