CFTC Proposes Amending CPO Exemption to Facilitate Cross-Border Activity

Commentary by Dorothy Mehta and Steven Lofchie

The CFTC proposed amending the conditions under which non-U.S. CPOs qualify for exemption from registration under CFTC Rule 3.10(c).

As proposed, the amended rule would allow a person or entity that is engaged in the activity of a CPO and legally domiciled outside of the United States to claim an exemption from CPO registration on a pool-by-pool basis in which no U.S.-domiciled persons invest (an "offshore pool"). In effect, a non-U.S. CPO, already registered or relying on other CPO exemptions, may claim the 3.10(c) exemption with respect to a specific pool meeting the specific criteria set forth in the proposed rule. The amended rule would also (i) create a conditional safe harbor for non-U.S. CPOs who cannot, due to the structure of their offshore pools, determine with certainty that such pools contain no U.S. investors, and (ii) allow the U.S.-based affiliates of fund sponsors to make initial capital contributions to such offshore pools without being considered U.S. investors for purposes of the exemption.

The proposed rulemaking reopens the comment period on the rule proposal, including commodity interests not subject to a clearing requirement in 3.10(c). See "Exemption from Registration for Certain Foreign Persons," 81 FR 51824. The non-clearing requirement proposal would be consistent with CFTC Staff Letters No. 16-08 and 15-37, which provided such relief.

In their public statements, the Commissioners asserted that the proposed rule would:

i. help the CFTC better prioritize its resources to protect U.S. investors by deferring to foreign regulators to oversee offshore pools;

ii. better reflect the reality that fund managers do not always have visibility into whether their pools contain U.S. investors due to trading in offshore secondary markets; and

iii. remove the uncertainty around whether CPOs may rely on the registration exemption on a pool-by-pool basis.

Comments must be submitted 60 days after the proposed rulemaking is published in the Federal Register.

Commentary

Today's proposal is a smart and market friendly move by the CFTC. Competing and conflicting interpretations of the application of CFTC Rule 3.10(c) to non-U.S. commodity pool operators, and global asset management firms, often came with burdensome if not unnecessary regulatory hurdles, and may have even contributed to the stall or closing of business lines. The proposed rulemaking mitigates those uncertainties and helps alleviate structural and operational barriers.

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Commentary

One structure that concerns Commissioner Berkowitz is as follows:

  • Adviser A manages a private fund with U.S. investors;

  • the fund establishes a subsidiary that is a non-U.S. CPO;

  • the non-U.S. CPO establishes a non-U.S. fund; and

  • Adviser A moves the money of the U.S. private fund investors into the non-U.S. commodity pool.

Had Adviser A simply established the non-U.S. pool and taken money from U.S. investors, Adviser A would be subject to CFTC registration. However, in the theoretical structure, because the U.S. private fund controls the non-U.S. CPO, the non-U.S. CPO (even though it is, as a matter, controlled by Adviser A) would not be subject to registration.

This is not an empty concern. However, as the adopting release notes (at page 24), this would be prohibited as an improper evasion of the CFTC's requirements. The CFTC should consider providing a more tailored definition of the term "control," so that it need not rely entirely on open-ended terms such as evasion.

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