Toward the end of 2015 and in the first few months of 2016, the Commodity Futures Trading Commission (“CFTC”) took action on several issues of interest to investment management firms that had been pending for quite some time. In case you missed these items due to the holiday season, year-end crises, or the winter doldrums, here are some brief summaries of the CFTC’s recent activities, as well as some noteworthy actions of National Futures Association (“NFA”).

Margin on Uncleared Swaps
On December 16, 2015, the CFTC adopted final regulations to govern margin on uncleared swaps.[1] The CFTC’s regulations largely followed those previously adopted by the banking regulators.[2] However, the CFTC did not finalize how these regulations will apply in a cross-border context, which is being handled in a separate rulemaking expected to be finalized in the next few months.

The regulations to govern margin on uncleared swaps are scheduled to begin to take effect on September 1, 2016, but only for the largest participants in the swaps market. It is likely the first direct impact on investment firms will be on March 1, 2017, when variation margin requirements are scheduled to begin applying generally. Firms that have not been accustomed to making daily variation margin postings should familiarize themselves with the new requirements and the types of acceptable collateral so that they and/or service providers are prepared to comply by the due date. Initial margin requirements are scheduled to be phased in over a four-year period and will be applicable generally as of September 1, 2020, for those firms that have a “material swaps exposure” as defined in the regulations. In the meantime, firms should be prepared to gather the necessary data to determine whether they have a material swaps exposure and to review arrangements with custodians and service providers. If a firm were to be subject to initial margin requirements, two-way posting of collateral will be required and the initial margin amounts posted by a swap dealer and financial end-user must be segregated at a third-party custodian independent from both parties to the swap.

Limited Exemption From Recordkeeping for Oral Communications
The Dodd-Frank Act requires that certain swaps be executed on or subject to the rules of a swap execution facility (“SEF”).  Because of this legislative requirement, certain investment managers that also act as commodity trading advisors (“CTA”) and/or commodity pool operators (“CPO”) under the Commodity Exchange Act (“CEA”) have considered becoming, or have actually become, members of a SEF to provide greater efficiency in trading swaps on behalf of clients or investors. CFTC Regulation 1.35(a) requires SEF members, among others, to keep records of oral communications that lead to the execution of a commodity interest transaction (“Oral Pre-Trade Communications”). The CFTC had previously exempted CPOs from this requirement, but only provided relief from its enforcement against CTAs through a series of time-limited staff no-action letters. On December 18, 2015, the CFTC amended Regulation 1.35(a) to exempt CTAs that are SEF members from the requirement to record and keep Oral Pre-Trade Communications.[3] This should make it easier for CTAs to become SEF members and thus better able to service client and investor needs regarding swap transactions.  However, subject to certain exceptions, these CPOs and CTAs that are SEF members must keep records of written communications that lead to the execution of a commodity interest transaction and related cash or forward transactions.

Regulation AT
On November 24, 2015, the CFTC proposed for public comment regulations that would govern automated trading on designated contract markets (“DCM”).[4] This proposal is wide-ranging, but of greatest interest to investment managers is the concept of an “AT Person,” which would include registered CPOs and CTAs that engage in automated trading as defined in the proposal. AT Persons would be subject to various requirements, including (1) pre-trade risk controls; (2) written policies and procedures regarding (i) development and testing of software; (ii) continuous real-time monitoring by knowledgeable staff; and (iii) training of appropriate personnel; (3) submission of an annual report concerning a firm’s automated trading activities; and (4) maintenance of a source code repository that would be open to inspection by any member of the CFTC staff or the U.S. Department of Justice. Due to the breadth of the proposal, the CFTC has provided a 90-day period for public comment, which expires on March 16, 2016.

Alternative to Fingerprinting of Foreign Natural Persons
Natural persons applying for registration as associated persons (“AP”) under the CEA or to be listed as principals of a firm are generally required to provide a fingerprint card as part of the application. The fingerprint card is transmitted to the Federal Bureau of Investigation (and sometimes to Interpol if the person has resided abroad recently) to determine if the person neglected to disclose criminal matters in his or her background. Some non-U.S. persons have objected to this requirement in the past, often citing cultural differences in home countries where fingerprinting is less prevalent than in the United States. As its first regulatory proposal of this year, on January 4, 2016, the CFTC proposed an alternative to the fingerprint requirement for natural persons located outside of the United States that would permit a sponsor of the person seeking registration as an AP or listing as a principal to certify that a criminal history background check for the individual has been performed within the past year and it revealed no matters that would constitute a statutory disqualification under CEA Sections 8a(2) or 8a(3).[5] The proposal codifies and broadens the relief previously provided by CFTC Staff Letters 12-49 (principals) and 13-29 (APs).[6]

Exemption From Registration for Non-U.S. Intermediaries
In another action that should help persons located outside the United States to access U.S. markets, the CFTC staff has issued a no-action letter that will make it easier for persons located outside the United States to act as intermediaries for customers, clients and investors that are also located outside the United States and seek to trade commodity interests on or subject to the rules of a DCM or SEF or opposite a U.S. counterparty in an off-exchange swap transaction. CFTC Regulation 3.10(c)(3)(i) exempts such non-U.S. intermediaries from registration under the CEA, provided the resulting transaction is submitted for clearing through a futures commission merchant registered under the CEA. In response to a request that the clearing requirement is unreasonable for swaps for which the CFTC has not adopted a clearing mandate, the no-action letter permits an intermediary that could otherwise claim exemption from registration under CFTC Regulation 3.10(c)(3)(i) to continue to be able to do so even if some of the transactions involved are uncleared swaps, provided there is no clearing mandate for such swaps.[7] The relief provided by the CFTC staff also benefits U.S. firms that sub-advise commodity pools or separately managed accounts of a CPO or CTA that wishes to take advantage of the exemption from registration under CFTC Regulation 3.10(c)(3)(i). These U.S. firms can now make investment decisions for the commodity pools or separately managed accounts involving uncleared swaps and remain in compliance with NFA Bylaw 1101, which prohibits NFA members from doing business with a person engaging in activity that generally requires registration under the CEA unless the person is so registered or exempt from such registration.

Re-Affirmation of Exemptions From Registration
Various claims of exemption from registration under the CEA must now be re-affirmed on an annual basis. For investment managers, this would include claims of CPO exemption under CFTC Regulation 4.5 for operators of certain types of collective investment vehicles (this is actually an exclusion from the CPO definition) or under CFTC Regulation 4.13(a)(3) based upon a de minimis amount of commodity interest trading by the pools operated, or claims of exemption from CTA registration under CFTC Regulation 4.14(a)(8) based upon the type of collective investment vehicle that a firm advises. Because 2016 is a leap year, the due date for re-affirmation is February 29, rather than March 1 as will be the case in most years. Re-affirmations must be made using NFA’s Electronic Exemption System.

As noted above, NFA Bylaw 1101 requires that NFA members not do business with firms acting in a capacity that generally requires registration under the CEA unless such other firm is so registered or is appropriately claiming exemption from registration. Investment managers that are NFA members, if they have not already checked whether firms with which they deal regarding commodity interest transactions (such as CTAs or sub-advisors) have re-affirmed their exemption claims, should do so promptly as part of their due diligence under NFA Bylaw 1101. Firms that previously claimed exemption and wish to remain active in commodity interest markets must either re-affirm the exemption, register in an appropriate capacity, or be able to claim a self-executing exemption, such as that provided by CEA Section 4m(1).

Cybersecurity
NFA’s Cybersecurity Interpretive Notice will become effective on March 1, 2016, and applies to all membership categories. The Cybersecurity Interpretive Notice requires each NFA member to adopt and enforce an information systems security program appropriate to its circumstances.

Notes:
[1] 81 Fed. Reg. 635 (January 6, 2016).

[2] 80 Fed. Reg. 74839 (November 30, 2015).

[3] 80 Fed. Reg. 80247 (December 24, 2015).

[4] 80 Fed. Reg. 78823 (December 17, 2015).

[5] 81 Fed. Reg. 1359 (January 12, 2016).

[6] CFTC Staff Letter 12-49, issued on December 11, 2012, is available at the following URL: http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/12-49.pdf,  and CFTC Staff Letter 13-29, issued on June 21, 2013 is available at the following URL: http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/13-29.pdf. 

[7] CFTC Staff Letter 16-08 (February 12, 2016), is available at the following URL: http://www.cftc.gov/idc/groups/public/@lrlettergeneral/documents/letter/16-08.pdf.