On December 5, 2016, the Commodity Futures Trading Commission (the "Commission" or "CFTC") released a Final Rule (the "Final Rule") regarding the aggregation provisions proposed in 2013 (the "2013 Proposal") and supplemented in 2015 (the "Supplement") for determining compliance with its speculative position limit rules. The Final Rule largely codifies the 2013 Proposal as amended by the Supplement, subject to certain modifications and clarifications. Notably, the Final Rule adopts the "owned entity" exemption as set forth in the Supplement so that any person who owns 10% or more (up to and including a 100% interest) of another entity will be permitted to obtain relief from having to aggregate the positions of the owned entity, upon filing a notice with the CFTC stating that certain specified conditions demonstrating its lack of trading control have been met. The owned entity itself would not be required to submit a separate notice filing in respect of the same positions or accounts.
The Final Rule is scheduled to become effective on February 14, 2017.
Background: The 2013 Aggregation Proposal
In 2013, the Commission proposed new position limit rules and aggregation standards for determining compliance with position limits. The 2013 Proposal would have generally required that a person aggregate positions in any account or entity in which it has a 10% or greater ownership interest, i.e., an owned entity, when determining compliance with the position limits, absent an available exemption. The 2013 Proposal retained the longstanding requirement that positions must be aggregated on the basis of control over trading and trading in concert (i.e., when two persons act pursuant to an express or implied agreement or understanding). The 2013 Proposal also included a new requirement that positions in more than one account or pool with substantially identical trading strategies must be aggregated, notwithstanding an otherwise available exemption.
Exemptions under the 2013 Proposal
The 2013 Proposal included existing aggregation exemptions for limited partners, shareholders and other pool participants, futures commission merchants and their affiliates, and independent account controllers.
The 2013 Proposal also added, among others, two new exemptions for the positions of owned entities, one applicable to an ownership interest in another entity between 10% and 50%, and the other applicable to a majority ownership interest in another entity.
Specifically, the 2013 Proposal would have established a notice filing procedure, effective upon submission, for relief from aggregation for a person with an ownership interest between 10% and 50% in another entity, provided that
(i) Such person (and any entity that such person must aggregate with) and the owned entity:
(A) do not have knowledge of the trading decisions of the other;
(B) trade pursuant to separately developed and independent trading systems;
(C) have and enforce written procedures to preclude each from having knowledge of, gaining access to or receiving data about trades of the other;
(D) do not share employees that control trading decisions;
(E) do not have risk management systems that permit the sharing of trades or trading strategy; and
(ii) Such person makes a notice filing with the CFTC, which is effective upon filing and includes a description of the circumstances and a statement of a senior officer certifying that the conditions of the exemption have been met.
In contrast, the proposed exemption for a person holding an ownership interest in an entity in excess of 50% was more limited in scope and subject to several additional requirements. Moreover, the relief for a person holding a greater than 50% ownership interest in another entity was not effective upon filing with the CFTC but solely in the CFTC's discretion, based on its review of the application and its process for determining whether such relief would be appropriate, with no time limit on the length of the review period.
In the Supplement, the CFTC proposed to eliminate the additional requirements for relief from aggregation in the case of an ownership interest in another entity in excess of 50%. Instead, any owner of 10% or more of an owned entity (up to and including 100% of an owned entity) would be permitted to disaggregate the positions of the owned entity using the same procedure and subject to the same set of criteria. The Supplement otherwise left the 2013 Proposal substantially unchanged, except for a few conforming amendments such as removing the greater than 50% cap in the exemption for broker-dealer activity.
The Final Rule
Though the Final Rule codifies the 2013 Proposal as amended by the Supplement largely as proposed, we have highlighted certain key modifications and clarifications, which are set forth below:
Owned Entity Exemption: The Commission has modified the language of this exemption to address concerns that an owner may not have knowledge of or the ability to find out about an owned entity's trading practices and thus should not be required to certify as to the owned entity's activities. Pursuant to this new language, a person seeking to rely on the owned entity exemption from aggregation must satisfy the criteria only to the extent the person is aware or should be aware of the activities and practices of the aggregated or owned entity. Additionally, the Final Rule provides further guidance with respect to particular criteria of the owned entity exemption, including the requirements for independent trading systems, written procedures for maintaining independence (including separate physical locations), and permissible scenarios for information sharing in relation to risk management.
Disaggregation for Special Situations: The Commission explicitly rejected commenter requests for specific exemptions or other specialized treatment for various types of entities or situations, such as investment companies, pension plans, passive index-tracking commodity pools, and cases of transitory ownership. However, the CFTC reiterated its existing authority under Section 4a(a)(7) of the Commodity Exchange Act to grant exemptions from the aggregation requirement on a case-by-case basis, irrespective of the enumerated exemptions in the Final Rule.
Notice Filing: The Final Rule provides for a 60-day grace period after an acquisition of an ownership interest in an owned entity to conduct due diligence and submit the required notice filing for an exemption. Thus, a notice filing made within 60 days after an acquisition would have retroactive effect as of the date of acquisition.
The CFTC is clarifying that a failure to timely file the notice would not be a violation of the aggregation requirement or of a position limit so long as the required filing is made within five business days after the person is aware, or should have been aware, that the notice has not been timely filed (though a violation of the filing requirement has occurred). However, relief is not available if a person is not eligible to claim an exemption from aggregation, but erroneously believes that it is, even if the error occurs in good faith.
The CFTC does not intend that notices be filed periodically, whether annually or otherwise; once a notice has been filed, an additional filing is required only in the event of a material change. The notice filing must be signed by a senior officer of the entity claiming relief from the aggregation requirement or, if the entity does not have senior officers, a person of equivalent authority and responsibility.
Filing by Affiliates: The Final Rule provides the option for one entity to file a notice for aggregation relief on behalf of any or all of its affiliates, so long as the criteria for relief are satisfied. A filing made on behalf of affiliates must be signed by a senior officer (or the equivalent) of each such affiliate.
Substantially Identical Trading: Notwithstanding the availability of any exemption, and even if its ownership interest in each account or pool is less than 10%, the Final Rule requires that any person aggregate its positions in all pools or accounts that have substantially identical trading strategies. The CFTC notes that it is only the person's pro rata interest (held or controlled) in each account or pool with substantially identical trading strategies that must be included in calculating the number of positions required to be aggregated, but this calculation would require knowledge of the positions held by the pools or accounts. The CFTC's stated rationale for this provision is to prevent circumvention of the aggregation requirement.
At present, the Final Rule only affects the contracts (futures contracts and options on futures contracts) subject to CFTC Rule 150 position limits (i.e., the so-called legacy contracts involving corn, oats, soybeans, wheat and cotton). However, it should be noted that the Commission is concurrently reproposing position limits that would apply to other physical commodity futures contracts and economically equivalent futures, options and swaps as well. Additionally, each major U.S. exchange has adopted similar aggregation rules, which apply to all contracts subject to position limits and traded on those exchanges.
The new notice filing requirement, which applies to most of the exemptions from aggregation in the Final Rule, will likely necessitate internal review of business activities and practices and working with affiliates in order to verify compliance with the applicable criteria and coordinate the submission of appropriate filings at the relevant entity or group level, as applicable.