Three days ago, reports came out that the CFTC could be putting to a private vote the requirement that managed futures mutual funds be subject to marketing and registration rules when they use derivatives tied to commodities, which include commodity futures, options and swaps. According to individuals who spoke on anonymity, the proposed regulation has been circulated for a vote by the CFTC’s five commissioners. The commissioners could end up voting on the proposed regulation or deciding to hold a public vote. If the proposal passes as adopted, managers to managed futures mutual funds would be required to register as commodity pool operators (CPOs) with the CFTC.
Background on CFTC Rule 4.5
As previously discussed in an earlier article on CFTC Rule 4.5, the issue of requiring mutual funds to register with the CFTC has been on the Commission’s radar for a long time. In part because of pressure from the NFA, the CFTC proposed changes to Rule 4.5 in February of 2011 which would require CPO registration for most managers to managed futures mutual funds. While the current rule exempts managers from the registration requirements, prior to 2003 mutual fund managers were required to register as CPOs unless they:
- restricted their commodities and futures marketing activity,
- limited commodity futures or options activity to bona fide hedging transactions, and
- limited the aggregate futures margins and/or options premiums for non-hedging positions to 5% of the liquidating value of the entity’s portfolio (after taking into account unrealized profits and losses).
When the CFTC amended Rule 4.5 in 2003, it eliminated the trading and marketing restrictions and as a result managed futures mutual funds currently market participation in their funds as managed futures funds and have more than 5% direct exposure to managed futures for speculative purposes. The February proposal seeks to reinstate the pre-2003 language in Rule 4.5.
It is important to note that the 5% limit in the proposed Rule 4.5 would apply to the entity filing for the Rule 4.5 exemption, not subsidiaries. Managed futures mutual funds are currently structured so that the managed futures investments are made through wholly-owned subsidiaries. Wholly-owned subsidiaries would not qualify for the 4.5 exemption unless each subsidiary independently met all the requirements set forth in the proposed amendment. Therefore, mutual funds (i) with an investment objective to provide exposure to physical commodities as an asset class and (ii) that do so by investing in commodity futures, options, and swaps via wholly-owned subsidiaries, must make sure that those subsidiaries qualify for Rule 4.5 as well.
If the CFTC approves the proposed regulation, it would subject many mutual funds to CFTC registration and oversight by the NFA.
Cole-Frieman & Mallon LLP provides advice to managers in the managed futures industry. The firm also has a robust alternative mutual fund practice led by Aisha Hunt. Bart Mallon can be reached directly at 415-868-5345. Aisha Hunt can be reached directly at 415-762-2854.