The U.S. Commodity Futures Trading Commission (CFTC) and U.S. futures exchanges set limits on the number of futures contracts that may be held or controlled by one person. CFTC and exchange rules also require “aggregation” of positions across multiple accounts in certain instances, but allow “disaggregation” of such accounts if certain narrow criteria are satisfied. While the CFTC and exchanges have historically had position limit, aggregation and disaggregation rules, the CFTC and U.S. futures exchanges have recently amended their rules to require persons seeking to disaggregate accounts that would otherwise be required to be aggregated to make certain notice filings with the CFTC and/or exchanges.1 Beginning August 14, 2017, CFTC staff no-action relief that had been issued relating to those notice requirements will expire,2 triggering CFTC notice filing requirements for fund managers seeking certain types of position limit disaggregation. The notice filing requirements of the U.S. futures exchanges were not subject to this no-action relief and may in some cases also require fund managers to make notice filings with the exchanges. Although industry groups have requested relief from the filing requirements, it is not yet clear whether that relief will be granted.
This Sidley Update provides an overview of the impact of the CFTC and futures exchange aggregation and disaggregation rules on fund managers.
CFTC and Exchange Position Limits
The CFTC currently sets position limits only on certain enumerated agricultural futures contracts. Each U.S. futures exchange (e.g., the exchanges operated by CME Group (CME) and ICE Futures (ICE)) also sets position limits for other futures contracts. The CFTC’s aggregation and disaggregation rules apply to those futures contracts for which the CFTC has established position limits, and the futures exchanges’ aggregation and disaggregation rules apply to all other futures contracts for which there are position limits. The futures exchanges’ rules are in some, but not all, cases identical to the CFTC’s rules.
A person must generally aggregate all positions in accounts or funds for which the person directly or indirectly controls trading or holds a 10 percent or greater ownership interest, as well as the positions of any other person with whom the person coordinates or controls trading pursuant to an express or implied agreement. Aggregation is not done on a pro rata basis, meaning that a person that controls or holds a 10 percent or greater interest in another entity may be required to count 100 percent of that entity’s futures positions in determining its own compliance with position limits.
The CFTC and each U.S. futures exchange also have rules that allow disaggregation. Certain of the aggregation exemptions require notice filings with the CFTC or the relevant exchange. The notice must include a description of the relevant circumstances that warrant disaggregation and a statement of a senior officer of the entity certifying that the conditions set forth in the exemption have been met. The aggregation exemptions most pertinent to investment funds are:
- Passive Shareholder Exemption: A person that is a limited partner, limited member, shareholder or other similar type of fund investor that directly or indirectly has a 10 percent or greater ownership or equity interest in a pooled vehicle need not aggregate the positions of the pooled vehicle with any other accounts or positions such person is required to aggregate. No filing is required, unless the person seeking to rely on the exemption is a principle or affiliate of a CPO. This exemption is not available to the pool operator and it is not available to an investor that holds a 25 percent or greater ownership interest in a pool operated pursuant to CFTC Rule 4.13. However, an investor that is an “eligible entity” (as defined in the CFTC’s rules) may be eligible to claim the independent account controller exemption discussed below as a partial alternative to the passive shareholder exemption.
- Owned Entity Exemption: Aggregation is not required where an owner that has a 10 percent or greater interest in an “owned entity” files a disaggregation notice demonstrating that both entities meet certain requirements, designed to ensure independence and lack of coordination, including having written procedures to prevent knowledge of each other’s trades. The owned entity exemption is not generally available to disaggregate an interest in a pooled account. A disaggregation notice describing how the requirements of the exemption have been met must be filed with the CFTC and/or exchanges.
- Independent Account Controller (IAC) Exemption: Aggregation is not required with respect to an account of an “eligible entity”3 managed by an “independent account controller”4 as long as the independent account controller does not exceed position limits and certain conditions designed to ensure independence and lack of coordination are met. This exemption does not apply to aggregation of positions in the spot month in physical-delivery contracts. A disaggregation notice describing how the respective requirements of eligible entity and independent account controller have been satisfied must be filed with the CFTC and/or exchanges.
For a more detailed overview, please consult prior Sidley Updates.5
Specific Issues for Fund of Funds
A fund of funds that makes passive investments in third-party funds typically would not be required to aggregate the futures positions of each of its underlying funds, even where the fund of funds owns a greater than 10 percent interest in an underlying fund, because it will generally be able to rely on the Passive Shareholder exemption described above.
The Passive Shareholder exemption is not available for a person, including a fund-of-funds, with a 25 percent or greater ownership in a pool operated under CFTC Rule 4.13. Thus, fund managers may wish to rely on the IAC exemption as the basis for disaggregating their positions in these 4.13 funds. However, unlike the other aggregation exemptions, the IAC exemption does not allow disaggregation of spot-month physical-delivery commodity contracts. Funds relying on the IAC exemption should consider what additional actions to take, such as limiting the discretion of underlying funds to hold physical-delivery contracts in the spot month, in order to avoid violating position limits as a result of aggregated spot-month positions.
Affiliates of CPOs
Generally, the Passive Shareholder exemption does not require a fund of funds to take any affirmative action to disaggregate the positions of an underlying fund. However, a notice filing requirement and other substantive requirements are triggered when an investment is made into a pool operated by a principal or affiliate of the CPO.
Specific Issues Related to Third-Party Managed Accounts
Information and Control Limitations
In many instances, entities that hold futures positions through third-party account managers will be able to rely on the IAC exemption with respect to those positions. However, to be eligible to rely on the IAC exemption, the entity seeking to disaggregate must authorize a third-party manager to control independently all trading decisions (without day-to-day direction from the entity) with respect to the positions it holds on the disaggregating entity’s behalf and the entity seeking to disaggregate may only maintain such minimum control over the third-party manager as is consistent with its fiduciary responsibility and duty to supervise the trading. Third-party managers also cannot have knowledge of trading done by other third-party trading managers used by the disaggregating entity.
Third-Party Managers Must Be Registered
In order to rely on the IAC exemption with respect to a third-party manager, the third-party manager must be registered as a futures commission merchant, introducing broker, commodity trading adviser (CTA), an associated person of any such registrant, or be a general partner of a commodity pool the operator of which is exempt from registration. Positions managed by non-registrants (e.g., exempt CTAs) cannot be disaggregated pursuant to the IAC exemption.
Specific Issues for Direct Investors in Futures
An entity that directly invests in futures contracts may be able take advantage of the IAC exemption if certain internal procedures are in place (e.g., informational walls and other information barriers placed between trading desks), such that the entity satisfies the requirements of the exemption.
Position limits can be an issue both for traders that directly hold futures contracts and also for traders that have exposure to futures contracts through investments in fund of funds or through third-party managed accounts. Managers should evaluate whether they are subject to position limits, whether the positions of multiple traders must be aggregated to determine their compliance with position limits, whether an aggregation exemption is available, and whether that aggregation exemption may require notice filings.