In light of the implementation of Title VII of the Dodd-Frank Act by the U.S. Commodity Futures Trading Commission ("CFTC") and consequential regulatory overhaul of the U.S. derivatives markets, many offshore investment funds and their advisers have expressed an interest in available exemptions from the registration requirements that apply to a commodity pool operator (CPO) or a commodity trading advisor (CTA).
In this posting, we focus on one such exemption – CFTC Rule 3.10, which is available to a qualifying operator and adviser of an offshore fund that conducts trading activities in the U.S. derivatives markets solely on behalf of non-U.S. customers. By way of key example, the exemption permits an offshore hedge fund or regulated fund (i.e., Irish UCITS fund) to buy or sell U.S. exchange-traded futures contracts – and someday soon U.S. SEF-executed swaps – without the fund’s operator or adviser having to register as a CPO or CTA, respectively.
As an introductory "housekeeping matter", It should be emphasized that earlier this week the CFTC delayed implementation of Title VII’s reforms until December 31, 2012. Notwithstanding that, in this posting we will speak as if swaps are subject to regulation – even though, that is not the case. For more on that delay, read our related May 10th posting by clicking here.
Background: Definitional Matters; Definitions Matter
Before turning to the substance of the Rule 3.10 exemption, it is helpful to review the nature of activity engaged in by CPOs and CTAs. In other words, before looking at the exemption itself, let’s briefly focus on some key definitional matters under the Commodity Exchange Act ("CEA").
- Commodity Pool – Section 1a(10) of the CEA defines a "commodity pool" as a pooled investment vehicle that is operated for the purpose of investing in futures contracts, swaps, and other specified investments subject to the regulatory jurisdiction of the CFTC ("Regulated Commodity interests").
- Commodity Pool Operator – Section 1a(11) of the CEA defines a CPO as any person (including any entity) engaged in a business that is in the nature of a commodity pool. By way of non-limiting example, an offshore fund’s governing board or entity with ultimate oversight responsibility would be the operator of the commodity pool.
- Commodity Trading Advisor – Section 1a(12) of the CEA defines a CTA as any person or entity who, for compensation or profit, engages in the business of advising others as to the value or advisability of trading in Regulated Commodity Interests.
Significantly, each statutory definition gives the CFTC discretionary authority to exempt persons from regulation as a CPO or CTA. And that brings us finally to CFTC Rule 3.10, the technical title of which is "Registration of futures commission merchants, introducing brokers, commodity trading advisors, commodity pool operators and leverage transaction merchants".
CFTC Rule 3.10 – Our Markets Are Your Markets (But Stay Away From Our Investors)
Given all of the introductory build-up, some of you may be hoping for something spectacular and complicated. Fortunately for the rest of you, the rule is quite simple. In short, the operator and advisor to an offshore fund will not need to register as a CPO or CTA, respectively, if two conditions are satisfied:
1) All exchange-traded futures, SEF-executed swaps or centrally cleared swaps are cleared through a CFTC registered futures commission merchant or "FCM"; and
2) All of the fund’s investors are located outside of the United States.
In respect of this last point, the CFTC made it quite clear that solicitation of U.S. persons is enough to disqualify a person seeking this exemption.
If a person located outside the U.S. were to solicit prospective customers in the U.S. as well as outside of the U.S., these exemptions would not be available, even if they only customers resulting from the efforts were located outside the U.S.
In closing, as you may have guessed by the official title of the rule, there is a similar exemption available for non-U.S. broker-dealers, as well. But that, our friends, is perhaps for another day.
Good day. Good exemption. TSR