The U.S. Commodity Futures Trading Commission (CFTC), on October 2, 2023, proposed a number of amendments to CFTC Regulation 4.7, that, if adopted, would create substantial new compliance obligations for commodity pool operators (CPOs) and commodity trading advisors (CTA) relying on the CFTC Regulation 4.7 exemptions and increase the monetary thresholds that certain investors must satisfy to qualify as “qualified eligible persons” (QEPs). CFTC Regulation 4.7, which a substantial number of institutional investment managers rely on globally, provides CPOs and CTAs with an exemption from many disclosure, reporting, and recordkeeping requirements otherwise applicable to such firms, subject to certain conditions. All participants in commodity pools operated under Regulation 4.7 must be QEPs, and all managed account clients of CTAs relying on Regulation 4.7 must be QEPs.
The proposal represents a major amendment of a regulation a significant portion of the investment management industry relies on — the first since the adoption of Regulation 4.7 in 1992. The proposed amendments would make three material categories of changes, as described in further detail below:
- new minimum disclosure rules for CPOs and CTAs that rely on Regulation 4.7
- codification of routinely issued exemptive letters allowing funds-of-funds operated under Regulation 4.7 more time to provide periodic account statements
- an increase of the monetary thresholds for certain investors, including natural persons, to be QEPs
The CFTC is also proposing technical amendments to its CPO and CTA regulations, including changes to Regulation 4.7. Those technical changes are not addressed in this Update.
The public comment period will close on December 12, 2023, 60 days after publication of the proposal in the Federal Register on October 12, 2023.
Disclosure Requirements
CPOs
The proposal would create new disclosure requirements for CPOs operating pools under Regulation 4.7, as follows:
- description of principal risk factors for the exempt pool
- description of the exempt pool’s investment program and use of proceeds
- description of fees and expenses
- description of conflicts of interest
- certain performance disclosures
If the proposal is adopted, Regulation 4.7 pools could no longer be offered without an offering memorandum (i.e., disclosure document), as is currently allowed.
CTAs
The proposal also would create new disclosure requirements for CTAs relying on Regulation 4.7, as follows:
- identification and description of certain persons, including the principals of the CTA, any futures commission merchant (FCM) and/or foreign exchange dealer, and any introducing broker
- description of principal risk factors of the trading program, including volatility, leverage, liquidity, and counterparty creditworthiness
- description of the CTA’s trading program, particularly its approach to offsetting positions
- description of each fee the CTA will charge to the client
- description of conflicts of interest
- certain performance disclosures
Many CTAs relying on Regulation 4.7 do not prepare and deliver to managed account clients any form of “disclosure document.” This new requirement will strike firms that act as CTAs to pools for which the firms are CPO as odd, as it would essentially require them to make the required disclosures to themselves.
Fund of Funds Account Statement Distribution
The proposal would codify routinely issued exemptive letters allowing CPOs of funds of funds operated pursuant to Regulation 4.7 to choose to distribute monthly account statements within 45 days of the month-end, rather than quarterly account statements within 30 days. A CPO relying on this relief would be required to notify its pool participants of this alternate distribution schedule.
QEP Definition
The proposal would increase the so-called “Portfolio Requirement” for certain persons to be treated as QEPs under Regulation 4.7. All participants in pools operated under Regulation 4.7 must be QEPs, and all managed account clients for which a CTA relies on Regulation 4.7 must be QEPs. The Portfolio Requirement applies to a number of categories of investors, including, among others, most operating companies, nonprofit organizations, and natural persons.
The Portfolio Requirement requires a person to satisfy either of two tests, or a weighted aggregate of both tests:
- the person must own securities (including pool participations) of issuers not affiliated with the person and other investments with an aggregate market value of at least $2 million, or
- the person must have on deposit with an FCM at least $200,000 in exchange-specified initial margin and option premiums, and required minimum security deposit for retail forex transactions.
The person may also satisfy a fractional portion of each test as long as the percentage by which the person meets each test, when added together, equals or exceeds 100%. For example, a person could satisfy the test with a combination of $1 million under the first test and $100,000 under the second test.
The proposal would double the monetary thresholds above to $4 million and $400,000, respectively. These thresholds were originally set in 1992, and the CFTC indicated that the proposed increases are intended to reflect inflation that has occurred since.
The increases in the monetary thresholds above will have a substantial impact on certain firms and no impact at all on other firms, depending on the nature of their client base. For example, for an institutional hedge fund manager that exclusively operates funds pursuant to Section 3(c)(7) of the Investment Company Act, the increased thresholds will have no real-world effect because the categories of persons who are permitted to invest in 3(c)(7) funds include types of QEPs that are not subject to the Portfolio Requirement. By contrast, a CTA running a non-pool trading program that is limited to natural person QEPs will have its universe of eligible investors substantially diminished.
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