The Need For Registration
Recent changes to U.S. Commodity Futures Trading Commission (CFTC) regulations mean that many fund managers must register with the CFTC before 31 December 2012. The reach of these regulations is extensive and may catch non-U.S. managers off-guard. If a fund uses derivatives1 and is offered or sold to U.S. persons, the CFTC will assert jurisdiction even if the fund is domiciled or regulated outside of the United States.2 While there are limited exemptions,3 it is expected that some fund managers, who are otherwise exempt from SEC registration, will now be required to register with the CFTC.
This article reviews the basic application of CFTC regulatory concepts in a number of jurisdictions where funds are commonly organized: Ireland, Luxembourg, Germany, Dubai, Hong Kong and Singapore.
Commodity Pool Operators and Commodity Trading Advisers
The type of CFTC registration required depends on what activities an entity undertakes. There are two categories particularly useful for fund managers:
- An entity that advises others on derivatives trading is required to register as a commodity trading adviser (CTA).
- An entity that: (a) operates a “commodity pool” (the CFTC’s term for collective investment schemes or vehicles); (b) can “hire and fire” the CTA; or (iii) markets the pool to U.S. investors would be required to register as a commodity pool operator (CPO).
Difficulties arise when applying these categories to non-U.S. fund structures. In some cases, there will be more than one CPO, triggering two separate registration requirements. While advisers and sponsors are frequently CPOs, for funds that are organized as corporations, each member of the board of directors is also a CPO. In the case of a limited partnership, the general partner is a CPO. In a trust structure, the trustee is deemed to be a CPO. This does not present an issue when, for example, the trustee is also the fund manager (as with most German collective investment schemes organized as Sondervermögen). But, in other cases, the presence of a board, general partner or trustee in addition to a fund manager will give rise to more than one requirement to register as a CPO. Subject to certain conditions, such a result can frequently be avoided by delegating the board/general partner/trustee’s CPO functions to the fund manager.
Germany: Most collective investment schemes (Sondervermögen) are sponsored and managed by a single entity (a management company — Kapitalanlagegesellschaft). Such a management company is likely to be both the CPO and CTA. However, in the case of investment vehicles with external, unaffiliated advisers, the analysis is more complex. If the external adviser gives advice only to the management company and has no authority to make investment decisions, it is not a CPO and may not even be a CTA. Where the management company instead delegates portfolio management to the external adviser, the external adviser is likely to be a CTA. In all cases, because the management company retains the right to hire and fire any external adviser, it is likely to be a CPO.
Ireland: Irish unit trusts, common contractual funds and investment limited partnerships all have managers that are responsible for the business and affairs of the scheme. The manager will appoint an investment manager with discretion to manage the scheme’s portfolio of investments. The manager is likely to be a CPO and the investment manager a CTA.
Irish self-managed investment companies are corporate vehicles managed by a board of directors that will delegate investment duties to an investment manager. As noted above, each individual director of a board of directors is likely to be a CPO. While a board of directors can, subject to certain requirements, delegate CPO responsibilities to a manager, that may not be possible if the board wishes to retain greater oversight over the scheme’s operations.
For Irish umbrella funds with sub-funds managed by distinct investment managers, the analysis will be highly fact sensitive. Each of the investment managers is likely to be a CTA on the basis that they are advising on a portfolio of investments that includes commodity interests. If these investment managers market their own sub-funds, this may trigger both CPO and CTA registration requirements.
Luxembourg: Funds in Luxembourg are organized either as investment companies (a corporate structure) or common funds (a contractual structure). Such funds must be represented by a management company. Funds may further delegate to an investment adviser. In the latter case, managers are likely to be CPOs and the investment advisers are likely to be CTAs. Note that any promotional activities by an investment adviser can prompt CPO registration requirements as well.
Dubai International Financial Centre (DIFC): Funds domiciled in the DIFC can take the form of a corporation, limited partnership or investment trust, constituted under the applicable laws in the DIFC. Due to DIFC regulations, most DIFC funds appoint an existing DIFC-domiciled “Fund Manager” (who has regulatory responsibility and the required DIFC regulatory permissions) to establish and operate funds. The fund board may be charged with making the investment decisions, although it often appoints another fund manager outside of the DIFC. Promotion and marketing of funds, as well as implementation of the fund investment policy, could take place at the level of the DIFC investment manager, board or even an external investment adviser. Both CPO and CTA functions can be performed in any of those entities.
Hong Kong and Singapore: In Hong Kong and Singapore, the use of a two-tier management structure is common. A Cayman Islands entity typically serves as an offshore manager, while a Hong Kong or Singapore entity acts as an onshore adviser/submanager. The onshore adviser is staffed with trading personnel who advise on derivatives trading. As a result, the onshore adviser will often be a CTA. But if personnel of the onshore adviser also market the fund to U.S. persons, this gives rise to a possible CPO registration requirement. The status of a Cayman manager is unclear and will depend on a case-by-case evaluation of the manager’s operations — an offshore manager generally retains the ability to hire and fire the onshore adviser, but it may not otherwise act as a CPO.
Ultimately, the determination of CPO/CPA status is fact sensitive. Where a particular entity does not have employees or other covered functions, it may be possible (or even required) to disregard such entity for CFTC registration purposes. Alternatively, subject to certain conditions, a manager may delegate all of its covered CPO/CTA functions to the adviser (or vice versa) in order to reduce the number of registrations required. The principal goal of such delegations should be to have to register only one entity as a CPO. CTA registration is comparatively easier to manage — useful exemptions still exist4 and the process of adding CTA registration to an entity’s CPO registration is simple. In either case, however, managers should consider whether the registration options chosen accurately reflect the managers’ operations.
Registration as a CPO and/or CTA: The Application Process
Managers should allot up to four months to complete the entire process to register as a CPO and/or CTA, although this can be completed in less time if all goes well.
But delays can occur even before the application is filed — all of the CPO/CTA’s “associated persons”5 must pass the National Commodity Futures Examination Series 3.6 The exam covers both theoretical and practical aspects of futures trading. While examinations are regularly scheduled, a large number of test-takers is expected in response to the CFTC’s new requirements — as a result, it may be necessary to book a seat days or weeks in advance. Furthermore, if a test-taker fails, he or she must wait a minimum of 30 days before scheduling the next examination. Information in relation to the test centers can be found on the FINRA website at http://apps. finra.org/TestCenter/1/locations.aspx.
The basic registration application form, Form 7-R, can be submitted electronically on the National Futures Association (NFA) website. The form requests standard identifying information and disclosure of any disciplinary issues. Related forms must be filed for each of the CPO’s principals and associated persons.7
A surprising aspect of CFTC registration is the requirement that each of a CPO’s or CTA’s “principals”8 and associated persons submit fingerprint cards on a Federal Bureau of Investigation form. A number of prospective CFTC registrants have found it difficult to locate officially-accepted methods to comply with this requirement.
The table below sets out the process of obtaining officially-accepted fingerprint cards in various jurisdictions.
Click here to view table.
While the paperwork associated with CPO and CTA registration is generally straight-forward, the process can be distracting and time-consuming. Registration is itself only a first step — new CPOs and CTAs must put into place additional compliance policies and procedures and make ongoing disclosure filings with the CFTC. But strategies to lessen these burdens exist — evaluating options now is the key to reducing compliance headaches before the CFTC’s 31 December deadline.