United States

Potential implications of CFTC exemption rescission on proprietary trading firms


On Feb. 24, 2012, the Commodity Futures Trading Commission (CFTC) issued final rules amending CFTC Part 4 Regulations to rescind an exemption from Commodity Pool Operator (CPO) registration for certain qualifying pools under CFTC Regulation 4.13(a)(4). Many entities that previously qualified for the 4.13(a)(4) exemption had until Dec. 31, 2012 to register with the CFTC and become CPO Members of National Futures Association (NFA).

The CFTC defines a CPO as “An individual or organization which operates or solicits funds for a pool, that is, an enterprise in which funds contributed by a number of persons are combined for the purpose of trading futures or options contracts.”

Proprietary trading firms that trade derivatives have historically relied on this exemption from CPO registration based on their unique business and structure. With this exemption rescinded, these firms have been exploring other available exemptions, whether to register, and the impact of registration.

Other available exemptions include the following:

4.13(a)(3) de minimis exemption

  • Must meet one of two tests:
    • The aggregate initial margin or premium does not exceed 5 percent of the liquidation value of the pool’s portfolio.
    • The aggregate net notional value of commodity interest positions does not exceed 100 percent of the liquidation of the pool’s portfolio.

4.5 exemption for otherwise regulated entities

  • Marketing restriction
    • The investment company cannot be marketed as a commodity pool or as a vehicle for trading in the commodity futures, options or swaps markets.
  • Trading restrictions
    • Commodity futures, commodity options and swaps trading must be for bona fide hedging purposes and any initial margins, and premiums required to establish transactions not considered as a bona fide hedge may not exceed 5 percent of the liquidation value of the pool’s portfolio.
    • The aggregate net notional value of commodity futures, options or swaps not used solely for bona fide hedging purposes must not exceed 100 percent of the liquidation value of the pool’s portfolio.

The decision to register is driven by many factors and considerations including ownership structure, exchange member status and status under other regulatory regimes (ie broker-dealer). This decision is a legal and compliance matter that should involve legal counsel and compliance consultants.

It is important to consider and understand the impact of registration. Along with the potential for routine regulatory exams conducted by the NFA, the CPO will have regulatory reporting requirements which include:

  • Account statements distribution within 30 days following the end of the reporting period
  • Quarterly reporting to the NFA and CFTC including the following:
    • Identity of specific relationships such as pool’s administrator, carrying broker(s), trading manager(s), etc.
    • Statement of changes in net asset value (equity) for the reporting period
    • Monthly performance for the period
    • Schedule of investments

Also, pool annual reports must be distributed to participants within 90 days, certified (audited) by an independent certified public accountant, and filed with the NFA.

Proprietary trading firms registering as a CPO and preparing pool financial statements will be faced with determining the appropriate presentation of their financial information. Traditionally, unregulated proprietary trading firms prepared financial statements more akin to a broker-dealer or commercial enterprise. Commodity pool financial statements are prepared using guidance from the Audit and Accounting Guide for Investment Companies issued by the American Institute of Certified Public Accountants (AICPA) as well as pursuant to specific CFTC regulations.

Commodity pool financial statements include a schedule of investments such as the reporting date, different income statement presentation, and financial highlights disclosures. The schedule of investments is required to disclose all investments by type of instrument, geography and industry or sector, and specifically identify all positions that are greater than five percent of the entity’s equity. The income statement is required to present a gross presentation of realized and unrealized gain or loss on investment activity and separately disclose the futures brokerage commissions incurred. Financial highlights disclosures include the rate of return and certain expense ratios.

Management will also need to determine the impact on operations. The NFA has certain requirements regarding the books and records to be maintained by the CPO. A proprietary trading firm many need to revise legal documents for compliance with applicable commodity pool laws and regulations. Finally, management will need to assess the applicability of the NFA assessment fees ($0.02 per half turn) to their trading activity, which could be substantial. NFA Notice I-12-33 issued on Dec. 19, 2012 notifies future commission merchants that for proprietary trading firms that become registered as CPOs with trading accounts that were exempt from the NFA assessment fee as of Dec. 31, 2012, they will remain exempt from the assessment fee until further notice from the NFA.

By Todd Briggs, partner, RSM US LLP, 312.634.3459 and Paul Nockels, partner, RSM US LLP, 312.634.4623