The Commodity Futures Trading Commission, on December 7, 2020, published in the Federal Register significant amendments to CFTC Regulation 3.10(c) (Amendments), making the regulation a more broadly available registration exemption for non-U.S. commodity pool operators (CPOs).1 The chief importance of the Amendments is that they will help non-U.S. CPOs to operate a “U.S.-facing” and “non-U.S. facing” pool business simultaneously;2 without subjecting the entire business of those CPOs to full CFTC regulation where that regulation is not necessarily warranted. The CFTC had unanimously approved the Amendments at an open meeting held on October 15, 2020.
Regulation 3.10(c)(3) currently provides an exemption from registration with the CFTC for any person located outside the United States, its territories or possessions, which is engaged in the activity of an introducing broker (IB), a commodity trading advisor (CTA) or a CPO. In order to qualify for this exemption, the commodity interest transactions that the IB, CTA or CPO executes bilaterally, or makes on or subject to the rules of any designated contract market or swap execution facility, must be executed only on behalf of persons located outside the United States, its territories or possessions.
Many non-U.S. managers of offshore pools that may trade in U.S. commodity interest markets rely on the exemption from registration as a CPO. In recent years, industry participants have raised various questions and issues regarding certain conditions for reliance on this exemption.3 The Amendments clarify and address these issues, and make the exemption more flexible and certain for non-U.S. entities that operate in reliance on one or more CPO registration or operational exemptions. This likely will result in additional entities being able to rely on the exemption.
Amendments to Regulation 3.10(c)
The Amendments restructure Regulation 3.10(c) to present the exemptions for CPOs, CTAs and IBs separately, and make certain substantive changes to the regulation. The modifications that are of particular note for non-U.S. asset managers that are CPOs and CTAs include those discussed below.
Operation on a Pool-by-Pool Basis and “Stacking”
The Amendments clarify that a CPO may rely on the Regulation 3.10(c) CPO registration exemption with respect to the qualifying offshore commodity pools it operates on a pool-by-pool basis, by specifying in the text of the regulation that the availability of the Regulation 3.10(c) exemption will be determined by whether all of the participants in a particular offshore pool are located outside of the United States.4 The Adopting Release states that the CFTC concluded that this change “properly tailors the [exemption] to address the increasingly global nature of the investment management space since 2007, without compromising the CFTC’s mission of protecting U.S. pool participants and effectively regulating CPOs managing U.S. assets.”5
Further, the Amendments explicitly provide that an offshore CPO is able to rely on the Regulation 3.10(c) CPO registration exemption with respect to qualifying commodity pools, and also register with the CFTC as a CPO or claim other relief from CPO registration with respect to other commodity pools (i.e., by “stacking” the Regulation 3.10(c) exemption, other CPO registration exemptions and registered status).6
Together, the Amendments explicitly allow a CPO located outside the United States to bifurcate its commodity pool business into groups of U.S.-facing and non-U.S. facing pools. Accordingly, a non-U.S. CPO may operate its U.S.-facing pools in its capacity as a registered CPO or in reliance on another CPO registration exemption or other relief, and may concurrently operate its non-U.S. facing pools in reliance on the Regulation 3.10(c) CPO registration exemption. This will allow such a non-U.S. CPO to not comply with the requirements otherwise applicable to a registered CPO or with the conditions to another exemption with respect to such non-U.S. facing commodity pools.7
Prior to the CFTC’s adoption of the Amendments, certain registered CPOs that operate non-U.S. facing commodity pools have relied on CFTC Advisory 18-96 with respect to such pools. CFTC Advisory 18-96 provides relief from the ongoing operational requirements that otherwise would be applicable to a registered CPO with respect to qualifying commodity pools other than the filing of CFTC Form CPO-PQR (the CFTC’s systemic risk report) and certain recordkeeping requirements.8 However, not all non-U.S. CPOs had been able to qualify for relief under CFTC Advisory 18-96 with respect to the non-U.S. facing commodity pools they operated, because the conditions to qualify for CFTC Advisory 18-96 are more stringent than the conditions for reliance on Regulation 3.10(c).9
Safe Harbor for Inadvertent U.S. Pool Participants
The Amendments provide a safe harbor for non-U.S. CPOs with respect to inadvertent U.S. participants in their offshore pools.10 Under this safe harbor, a pool will be considered to be operated in compliance with the requirement that all pool participants are “foreign located” persons or international financial institutions (discussed below), as long as certain conditions “minimizing possible U.S. participants in the covered offshore pools” are satisfied.11
Seed Capital Exception
The Amendments provide an exception to allow initial capital to be contributed to a commodity pool by an affiliate12 of the CPO, so long as: (1) the affiliate is not a natural person; (2) the affiliate and its principals are not barred or suspended from participating in commodity interest markets in the United States, its territories or possessions; and (3) interests in the affiliate are not marketed as providing access to trading in commodity interest markets in the United States, its territories or possessions.13 This change will allow CPOs that are not located in the United States to launch non-U.S. facing pools using a U.S. affiliate’s seed capital without losing the benefits of the CPO registration exemption under Regulation 3.10(c). Previously, a non-U.S. CPO in such a situation either: would have needed to register as a CPO; or ensure that it qualified for the CPO registration exemption available under Regulation 4.13(a)(3) while U.S.-sourced capital remained in the commodity pool.
Elimination of Clearing Requirement
The Amendments provide relief from the condition (noted above) requiring clearing of commodity interest transactions by CPOs and CTAs, unless the specific commodity interest transaction is required or intended to be cleared on a registered derivatives clearing organization (DCO).14 This codifies the 2016 CFTC staff relief on the subject.
Reliance on 3.10(c) with respect to International Financial Institutions
The amendments specifically allow an exempt CPO or CTA relying on Regulation 3.10(c)(3) to engage in relevant activity on behalf of an “international financial institution,”15 even if such institution has its headquarters or a significant presence in the United States.
Effective Date
The amendments will become effective on February 5, 2021.
Conclusion
In an increasingly global marketplace for asset managers operating commodity pools and advising separately managed accounts that trade commodity interests, the changes and clarifications to Regulation 3.10(c) will reduce burdens on CPOs, as well as allow the CFTC to focus on the oversight of domestic firms and the protection of U.S. person investors, consistent with the CFTC’s longstanding policy as discussed in the Adopting Release.
In addition, the CFTC declined to take action on certain issues that commenters raised in public comments on this rulemaking, including a request that the CFTC explicitly allow non-U.S. CTAs advising U.S. and non-U.S. separately managed accounts to comply with the CTA registration exemption under Regulation 3.10(c) on an account-by-account basis. The Adopting Release notes that the CFTC declined to take action on this request because the concept was not included in the CFTC’s proposal; however, the Adopting Release did not state that the CFTC disagreed with providing such relief. It appears that the opportunity for further discussion with the CFTC on issues affecting asset managers in the global marketplace remains open.
Footnotes
1) Exemption from Registration for Certain Intermediaries (Adopting Release), RIN 3038-AE46, 85 Fed. Reg. 78718 (Dec. 7, 2020).
2) This OnPoint refers to pools intended for investment of U.S.-sourced capital as “U.S. facing” pools and pools intended solely for investment of non-U.S.-sourced capital as “non-U.S. facing” pools.
3) For example, prior to the Amendments, this exemption was subject to a condition that any relevant commodity interest transaction must be submitted for clearing through a registered futures commission merchant. The CFTC Division of Swap Dealer and Intermediary Oversight granted no-action relief with respect to this condition in 2016, which was in effect at the time of the Amendments. See CFTC Letter No. 16-08 (Feb. 12, 2016).
4) Regulation 3.10(c)(5)(i). As amended, the exemption now provides that a “foreign located person engaged in the activity of a [CPO], in connection with any covered transaction is not required to register in such capacity, when such covered transactions are executed on behalf of a commodity pool, the participants of which are all foreign located persons or international financial institutions ...” The term “foreign located person” is defined to mean “a person located outside the United States, its territories, or possessions.” Regulation 3.10(c)(1)(ii). See note 15 below for the definition of the term “international financial institution” under amended Regulation 3.10(c).
The Adopting Release highlights the CFTC’s view that Regulation 3.10(c)(3) limited CPOs’ reliance on the exemption to those non-U.S. CPOs whose commodity interest transaction activities have been limited to acting on behalf of offshore commodity pools with no U.S.-sourced capital (i.e., the CPO could not operate commodity pools organized in the United States or with U.S.-sourced capital concurrent with reliance on Regulation 3.10(c)(3)). Adopting Release, text accompanying n. 19. The Adopting Release also highlights comments on a related CFTC rule proposal, stating that the CFTC had never addressed “whether an offshore CPO may rely on [Regulation] 3.10(c)(3)(i) with respect to some of its offshore pools in combination with relying on other exemptions with respect to its other pools,” and requesting the CFTC affirm that a CPO may claim the exemption under Regulation 3.10(c)(3) on a pool-by-pool basis and rely on that exemption in addition to other exemptions, exclusions, or registration. Id.
5) Adopting Release, text following n. 104. The Adopting Release also notes that this change recognizes that certain of the largest CPOs in the market (measured by assets under management) are located outside of the United States, and “typically operate many different commodity pools simultaneously, including some pools for U.S. investors and other pools for investors outside of the United States.” Id., text accompanying n. 98.
6) Regulation 3.10(c)(5)(iv).
7) Any CPO relying on Regulation 3.10(c) will be subject to the Commodity Exchange Act (CEA) anti-fraud and anti-manipulation provisions. In addition, any trading on U.S. exchanges and with U.S. counterparties will still be subject to applicable CEA provisions and CFTC regulations (e.g., position limits, large trader reporting, and Dodd-Frank Act swaps trading requirements, as applicable).
8) CFTC Advisory 18-96 (Apr. 11, 1996). The requirement to file CFTC Form CPO-PQR is set forth in Regulation 4.27, a regulation that the CFTC adopted after CFTC Advisory 18-96 was issued.
9) The conditions to qualify for the CFTC Advisory 18-96 relief are as follows:
1. The CPO claiming the relief must be registered as a CPO with the CFTC;
2. The commodity pool must be, and remain, organized and operated outside of the United States;
3. The commodity pool may not hold meetings or conduct administrative activities within the United States;
4. No shareholder of or other participant in the commodity pool may be a United States person;
5. The commodity pool may not receive, hold or invest any capital directly or indirectly contributed from sources within the United States; and
6. The CPO, the commodity pool and any person affiliated therewith may not undertake any marketing activity for the purpose, or that could reasonably be expected to have the effect, of soliciting participation from United States persons.
10) Regulation 3.10(c)(5)(iii).
11) Adopting Release, at text following n. 128. The conditions to the safe harbor include that: (A) the commodity pool is organized and operated outside of the United States, its territories or possessions; (B) the commodity pool’s offering materials and any underwriting or distribution agreements include clear, written prohibitions on the commodity pool’s offering to participants located in the United States and on U.S. ownership of the commodity pool’s participation units; (C) the commodity pool’s constitutional documents and offering materials: (1) are reasonably designed to preclude persons located in the United States from participating therein; and (2) include mechanisms reasonably designed to enable its operator to exclude any persons located in the United States that attempt to participate in the offshore pool, notwithstanding those prohibitions; (D) the CPO exclusively uses non-U.S. intermediaries for the distribution of participations in the commodity pool; (E) the CPO uses reasonable investor due diligence methods at the time of sale, to preclude persons located in the United States from participating in the commodity pool; and (F) the commodity pool’s participation units are directed and distributed to participants outside the United States, including by means of listing and trading such units on secondary markets organized and operated outside of the United States, and in which the CPO has reasonably determined that participation by persons located in the United States is unlikely.
12) The term “affiliate,” or a person “affiliated with,” a specified person is defined in CFTC Regulation 4.7(a)(1)(i) as “a person that directly or indirectly through one or more persons, controls, is controlled by, or is under common control with the specified person.” The Adopting Release states that the term “control” is defined by reference to Securities and Exchange Commission Rule 405 of Regulation D, and “as ‘the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.’” Adopting Release, n. 155.
13) Regulation 3.10(c)(5)(ii).
14) Regulation 3.10(c)(5)(i). As amended, the exemptions from registration as a CPO or CTA are conditioned on: (1) clearing on a DCO any commodity interest transaction that is required or intended to be cleared on a registered DCO; and (2) clearing such transactions through a registered futures commission merchant, unless the pool/client is a clearing member of the relevant DCO. Commodity interest transactions that are not required or intended to be cleared are not subject to this condition.
15) The term “international financial institution” is broadly defined to mean “the International Monetary Fund, the International Bank for Reconstruction and Development, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the United Nations, the European Stability Mechanism, the North American Development Bank, those institutions defined as ‘international financial institutions’ in 22 U.S.C. 262r(c)(2), those institutions defined as ‘multilateral development banks’ in Article 1(5(a)) of Regulation (EU) No 648/2012 of the European Parliament and of the Council on OTC Derivative Transactions, Central Counterparties and Trade Repositories, their agencies and pension plans, and any other similar international organizations, and their agencies and pension plans.” Regulation 3.10(c)(1)(iii).
