The Commodity Futures Trading Commission (“CFTC”) is seeking public comment on a petition submitted by the National Futures Association (“NFA”), a leading futures industry self-regulatory organization, to amend CFTC Rule 4.5, which provides an exclusion from the term “commodity pool operator” (“CPO”) for specified persons operating certain otherwise regulated collective investment vehicles referred to therein as “qualifying entities” such as registered investment companies that engage in trading futures contracts or options on futures contracts.1 Comments are due on or before October 18, 2010.
Rule 4.5 requires an eligible person intending to claim the exclusion to file a notice of eligibility with NFA, which must identify the qualifying entity to be operated pursuant to the exclusion and include representations that the qualifying entity (i) will disclose in writing to each existing or prospective participant that the qualifying entity is operated by a person who has claimed an exclusion from the definition of the term “CPO” under the Commodity Exchange Act, and therefore, who is not subject to registration or regulation as a CPO under the Commodity Exchange Act and (ii) will submit to such special calls as the CFTC may require to demonstrate compliance with Rule 4.5. Rule 4.5 does not currently include any substantive limitations on the nature or extent of futures or options on futures trading in which a qualifying entity may engage or on the manner in which a qualifying entity will be marketed to the public.
NFA is requesting that the CFTC amend Rule 4.5 to limit the scope of the CPO exclusion for registered investment companies that trade futures contracts or options on futures contracts. To be able to rely on Rule 4.5 and thereby obviate the need for CPO registration and complying with the CFTC’s disclosure, reporting and recordkeeping requirements for CPOs, an investment company would be required to represent as well that (i) its use of futures contracts and options on futures contracts will be limited to bona fide hedging positions as defined in the CFTC’s rules, provided that, initial margin and premiums for any nonhedging positions “that may be held by a qualifying entity only,” i.e., the registered investment company itself, will not exceed 5% of the liquidation value of the qualifying entity’s portfolio; and (ii) it will not be marketed to the public as a commodity pool or as a vehicle for trading in or otherwise seeking investment exposure to the commodity futures or commodity options markets.
These restrictions are generally similar to trading and marketing limitations which were contained in Rule 4.5 prior to 2003. However, the addition of the phrase “that may be held by a qualifying entity only” is apparently also intended to preclude an entity other than the registered investment company itself from being able to rely on Rule 4.5. For example, if amended as requested by NFA, it would appear that a wholly-owned subsidiary of a registered investment company would be unable to rely on Rule 4.5 without also separately satisfying the criteria of Rule 4.5.