On December 4, 2012, the Division of Swap Dealer and Intermediary Oversight (the "Division") of the Commodity Futures Trading Commission ("CFTC") issued CFTC Letter No. 12-40 (the "Letter"). The Letter grants no-action relief with respect to operators of business development companies ("BDCs") that fail to register as commodity pool operators ("CPOs"). The issue addressed in the Letter arises from the revised definition of "commodity pool operator" brought about by the Dodd-Frank Wall Street Reform and Consumer Protection Act, which expanded the definition of "commodity interests" to include "swaps" and therefore conferred commodity pool status on any fund or similar enterprise that entered into any swap. As a result, operators of such funds or other similar enterprises would either have to register, or claim an exemption from registering, as CPOs, in either case by December 31, 2012.
In the Letter, the Division recognized a number of similarities between BDCs and investment companies ("RICs") registered under the Investment Company Act of 1940, as amended (the "ICA"). Among the similarities noted by the Division are these entities' level of regulation and examination; the manner of permitted usage of swaps and certain other derivative contracts; their use of external, regulated advisers; and their required compliance with disclosure and other requirements set forth in the Securities Exchange Act of 1934, as amended. In addition, the Division stated in the Letter that almost all BDCs are listed for trading on national securities exchanges and are therefore subject to exchange rules, including investor protections, governing listed companies. The Division differentiated between BDCs and RICs by noting that while RICs typically use derivatives as a source of leverage, BDCs tend to limit their use of derivatives for the purpose of hedging, reducing, or managing investment and commercial risks, all stemming from the role of BDCs as investors in, and managers of, operating companies.
However, the Division nonetheless concluded that BDCs that utilized swaps were properly considered commodity pools, and absent relief from the Division, their operators would be required to register as CPOs. Notwithstanding that conclusion, the Division decided, for the reasons set forth in the preceding paragraph, not to recommend that the CFTC take enforcement action against the operator of a BDC that failed to register as a CPO, provided that:
- The BDC has elected to be treated as a BDC under Section 54 of the ICA with the Securities and Exchange Commission and continues to be regulated as such;
- The BDC will not be, and has not been, marketing participations to the public as or in a commodity pool or otherwise as or in a vehicle for trading in the commodity futures, commodity options, or swaps markets; and
- Either (i) the BDC uses commodity futures or commodity options contracts or swaps solely for bona fide hedging purposes within the meaning of CFTC Rules 1.3(z)(1) and 151.5, provided that with respect to the foregoing instruments that do not come within the meaning and intent of the foregoing CFTC Rules, the aggregate initial margin and premiums required to establish such positions do not exceed five percent of the liquidation value of the BDC's portfolio (after taking into account certain adjustments); or (ii) the aggregate net notional amount of commodity futures, commodity options contracts, or swaps positions not used solely for bona fide hedging purposes within the meaning and intent of the CFTC Rules specified in the foregoing clause, determined at the time the most recent position was established, does not exceed 100 percent of the liquidation value of the BDC's portfolio (after taking into account certain adjustments).
The language contained in paragraph 3 above closely mirrors that contained in other CFTC Rules, particularly Rule 4.13(a)(3), the so-called "de minimis" exemption. However, the exclusion of certain instruments used for bona fide hedging purposes from the calculations contained in paragraph 3 is unique to date to the case of BDCs, as other types of funds are not entitled to exclude swaps entered into for bona fide hedging purposes from their de minimis exemption calculations.
The Letter expressly states that a BDC that seeks to avail itself of the no-action relief must file a claim to use the relief; it is not self-executing. Such claim must: (i) state the name, main business address, and main business telephone number of the BDCs for which the relief is being claimed; (ii) be signed by a person authorized to bind the BDC; and (iii) be filed with the Division using the email address "email@example.com" with "BDC" in the subject line, prior to December 31, 2012 (for a BDC in operation as of December 1, 2012) or otherwise within 30 days after a BDC begins to operate as such.
The Letter may be accessed here.