By Tom Watterson and Crystal Travanti
As the second part of our ongoing series on the 2014 CFTC Reauthorization Act, we wanted to highlight what could become important relief for mutual funds and their investment advisers with respect to registration as commodity pool operators (“CPOs”) or commodity trading advisers (“CTAs”).
In a late addition to the proposed 2014 CFTC Reauthorization Act, the House added a section 361, “Treatment of certain funds”, amending the definitions of a CPO and CTA in the Commodity Exchange Act to exclude investment advisers of mutual funds (registered investment companies) in certain circumstances. Section 361, as passed by the House, excludes from the definition of a CPO, investment advisers that provide advice to mutual funds where the only “commodity interests”, or CFTC regulated products, that the mutual fund invests in are “financial commodity interests.” Similarly, section 361 excludes from the definition of a CTA, investment advisers who provide advice to mutual funds where the adviser provides advice on commodity interests only in relation to “financial commodity interests.”
Section 361 would define “financial commodity interests” as “a futures contract, an option on a futures contract, or a swap, involving a commodity that is not an exempt commodity or an agricultural commodity.” Practically, a financial commodity interest would be a swap or future on interest rates, credit, foreign exchange, stock indices, indices based on rates or prices. For example, an adviser of a mutual fund using treasury futures to manage its duration, or using credit default swaps to gain credit exposure to certain entities would be covered by the exclusion in section 361. The exclusion would not apply to advisers of mutual funds that use futures or swaps on agricultural or energy products.
Prior to 2012, CFTC Rule 4.5 excluded investment advisers to mutual funds from the definitions of a CPO or CTA. In February of 2012, the CFTC released final rules amending CFTC Rule 4.5 to add a requirement that mutual funds relying on the exclusion limit futures and commodity option positions other than bona fide hedging positions to a de minimis level of the funds total assets. At the same time, the Dodd-Frank Act included an expanded definition of a “swap” and included swaps as “commodity interests”. Together with the amendments to CFTC Rule 4.5, these change resulted in a significant number of mutual funds becoming subject to the dual regulatory regimes of the SEC and the CFTC. In addition, even if not subject to full CFTC regulation, mutual funds now have an additional compliance burden to track their commodity interest exposure with respect to the Rule 4.5 limits.
Although the CFTC released rules harmonizing the disclosure rules for mutual funds subject to SEC regulation, investment advisers to mutual funds that must register as CPOs still undergo an increased regulatory burden. Section 361 of the 2014 CFTC Reauthorization Act seeks to remove the additional burdens added by the 2012 revisions of CFTC Rule 4.5 for advisers to those mutual funds that only trade “financial” CFTC regulated products.
The House bill on the 2014 CFTC Reauthorization Act is available here.
Mutual funds will want to keep up-to-date with this section of the 2014 CFTC Reauthorization Act as the bill progresses. The Swap Report
Special thanks to Renold Sossong for his assistance with this post