Category Archives: cftc

CFTC Head Addresses Futures Industry in Chicago

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Futures Industry Association Annual Expo

CFTC Chairman Gary Gensler today spoke at the Futures Industry Association’s annual expo in Chicago. While most of the Chairman’s speech  focused on the proposed regulation of the OTC derivatives markets, Chairman Gensler also discussed the recent SEC and CFTC Harmonization report. As you can imagine, Gensler is for increasing regulation of the entire financial markets. Below I have included some of the more interested quotes which can be found in the text of the speech text of Chairman Gensler’s speech.

The CTA Expo was going on as well during this time and I will be writing more articles on the speakers at this conference over the next few days.

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Both of the committees’ bills include three important elements of regulatory reform: First, they require swap dealers and major swap participants to register and come under comprehensive regulation. This includes capital standards, margin requirements, business conduct standards and recordkeeping and reporting requirements. Second, the bills require that dealers and major swap participants bring their clearable swaps into central clearinghouses. Third, they require dealers and major swap participants to use transparent trading venues for their clearable swaps.

The challenge remains, though, determining which transactions should be covered by these reforms. I believe that we must bring as many transactions under the regulatory umbrella as possible. This will best accomplish the two principal goals of reform: lowering risk to the American public and promoting transparency of the markets.

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To promote market transparency, all standardized OTC products should be moved onto regulated exchanges or trade execution facilities. This is the best way to reduce information deficits for participants in these markets. Transparency greatly improves the functioning of the existing securities and futures markets. We should shine the same light on the swaps markets. Increasing transparency for standardized derivatives should enable both large and small end-users to obtain better pricing on standard and customized products.

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Some have articulated a false choice between stronger regulation on the one hand and a free market on the other. Rules improve markets, however, by enhancing efficiency and integrity. Traffic lights require you to stop your car, but they also ensure that traffic is orderly and efficient. They reduce risks for every person on the highway. Similarly, this country’s markets work best with clear rules of the road.

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Last year’s crisis also highlighted the need for regulators to change. In that regard, the CFTC last week released a joint report with the SEC to bring greater consistency, where appropriate, to our regulatory approaches. While the missions of the CFTC and the SEC may differ, our goal is the same: to protect the public, enhance market integrity and promote transparency. In preparing our report, we set turf aside and focused on those changes that would best benefit the markets and the American people.

We jointly made 20 recommendations where we can change our statutes and regulations to enhance both agencies’ enforcement powers, strengthen market and intermediary oversight and facilitate greater operational coordination.

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Other related hedge fund law articles include:

CTA Expo 2009

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Commodity Trading Advisor Conference

Next week there will be a conference for Commodity Trading Advisors held in Chicago at the Hotel Monaco.  The conference, entitled the CTA Expo 2009, will be held on Wednesday and will feature a variety of topics of interest to CTAs.  The agenda includes:

I will be representing my firm, Cole-Frieman & Mallon LLP, at the conference and I look forward to meeting with the different traders and service providers at the event.  Each entrant will also receive a CTA Directory which will include a “tear sheet” on all of the groups which attended.  Please see the Cole-Frieman & Mallon LLP description of CTA services.

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Event information can be found here.  There is also a CTA Expo LinkedIn Group.

CTA EXPO 2009
October 21, 2009
Hotel Monaco Chicago, Illinois

CTA EXPO consists of a day of roundtables and seminars for Commodity Trading Advisors on marketing strategy combined with an all day schedule of thirty minute presentations by individual CTAS to small groups of professional money raisers, asset allocators and interested clients who are seeking to identify additional trading talent.

The debut conference in 2008 sold out in advance and was attended by over thirty-five CTAs and over sixty people who registered as professional money raisers and asset allocators. We have increased capacity for 2009 and interest in this year’s event has already been tremendous and we are anticipating another sold out event.

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The hedge fund law blog is committed to providing useful and easy to understand information for CTAs and CPOs which can be found in our CTA and CPO Registration and Compliance Guide.  For more information on registration or compliance services please contact Bart Mallon, Esq. at 415-868-5345.

OTC Derivatives Markets Act of 2009 Passes House Committee Vote

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CFTC Chairman Gensler Applauds “Historic Progress”

In a first step towards increased regulation of the over-the-counter derivatives markets, the House Financial Services Committee approved the Over-the-Counter Derivatives Markets Act of 2009.  The act is one of several initiatives to increase regulatory oversight of the financial markets and if passed by Congress would be signed into law by President Obama. Among other things the act would require Swap dealers and major swap participants to register with either the CFTC or the SEC.

Below I have reprinted press releases from both the House Financial Services Committee and the CFTC.

UPDATE: The Securities Industry Financial and Markets Association (SIFMA) just issued a press release reposted below as well.

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Financial Services Committee Approves Legislation to Regulate Derivatives

Committee completes work on a key element of President Obama’s plan to bring accountability and responsibility to Wall Street

Washington, DC – {The House Financial Services Committee today approved legislation that would, for the first time ever, require the comprehensive regulation of the over-the-counter (OTC) derivatives marketplace. Today’s bill, which was approved by a vote of 43-26, represents a key part of a broader effort by Congress and President Obama to modernize America’s financial regulatory system in response to last year’s financial crisis.

Under the bill, all standardized swap transactions between dealers and large market participants, referred to as “major swap participants,” would have to be cleared and must be traded on an exchange or electronic platform. A major swap participant is defined as anyone that maintains a substantial net position in swaps, exclusive of hedging for commercial risk, or whose positions creates such significant exposure to others that it requires monitoring. OTC derivatives include swaps, which are contracts that call for an exchange of cash between two counterparties based on an underlying rate, index, credit event or the performance of an asset.

The legislation then sets out parallel regulatory frameworks for the regulation of swap markets, dealers, and major swap participants.  Rulemaking authority is held jointly by the Commodity Futures Trading Commission (CFTC), which has jurisdiction over swaps, and the Securities and Exchange Commission (SEC), which has jurisdiction over security-based swaps.   The Treasury Department is given the authority to issue final rules if the CFTC and SEC cannot decide on a joint approach within 180 days. Subsequent interpretations of rules must be agreed to jointly by the Commissions.

Description of the Over-the-Counter Derivatives Markets Act of 2009

Clearing

The legislation provides a mechanism to determine which swap transactions are sufficiently standardized that they must be submitted to a clearinghouse. For transactions that are clearable, clearing is a requirement when both counterparties are either dealers or major swap participants.  Clearing organizations must seek approval from the appropriate regulator—either the CFTC or the SEC—before a swap or class of swaps can be accepted for clearing.

Transactions in standardized swaps that involve end-users are not required to be cleared. Such customized transactions must, however, be reported to a trade repository.

Mandatory Trading on Exchange or Swap Execution Facility

A standardized and cleared swap transaction where both counterparties are either dealers or major swap participants must either be executed on a board of trade, a national securities exchange or a “swap execution facility”—as defined in the legislation.  If none of these venues makes a clearable swap available for trading, the trading requirement would not apply.  Counterparties would, however, have to comply with transaction reporting requirements established by the appropriate regulator.  The legislation also directs the regulators to eliminate unnecessary obstacles to trading on a board of trade or a national securities exchange.

Registration and Regulation of Swap Dealers and Major Swap Participants

Swap dealers and major swap participants must register with the appropriate Commission and dual registration is required in applicable cases.  Capital requirements for swap dealers’ and major swap participants’ positions in cleared swaps must be set at greater than zero.  Capital for non-cleared transaction must be set higher than for cleared transactions.  The prudential regulators will set capital for banks, while the Commissions will set capital for non-banks at a level that is “as strict or stricter” than that set by the prudential regulators.

The regulators are directed to set margin levels for counterparties in transactions that are not cleared.   The regulators are not required to set margin in transaction where one of the counterparties is not a dealer or major swap participant.  In cases where an end user is a counterparty to a transaction, any margin requirements must permit the use of non-cash collateral.

Reporting and Public Disclosure of Swap Transactions

Reporting and recordkeeping is required for all over-the-counter derivative transactions.  Clearing organizations must provide transaction information to the relevant Commission and a designated trade repository.   Swap transactions that are not cleared and for which no trade repository exists, must be reported directly to the relevant Commission.   The legislation also provides for public disclosure of aggregate data on swap trading volumes and positions—in a manner that does not disclose the business transactions or market position of any person.  Large positions in swaps must also be reported directly to regulators.

Swap Execution Facilities

Swap execution facilities, or facility for the trading of swaps that are not Boards of Trade or National Securities Exchanges, must register with the relevant regulator as a swap execution facility (SEF).  SEFs must also adhere to core regulatory principles relating to enforcement, anti-manipulation, monitoring, information collection and conflicts of interest, among others. The CFTC and SEC are required to prescribe joint rules governing the regulation of swap execution facilities.  A Commission may exempt a SEF from registration if it is subject to comparable, comprehensive supervision and regulation by another regulator.

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Statement of Chairman Gary Gensler on House Financial Services Committee Passage of OTC Derivatives Regulatory Reform Legislation

October 15, 2009

Washington, DC – U.S. Commodity Futures Trading Commission Chairman Gary Gensler today commented on the OTC Derivatives Markets Act of 2009, passed this morning by the House of Representatives Committee on Financial Services.

Chairman Gensler said:

“Today’s vote by the House Financial Services Committee represents historic progress toward comprehensive regulatory reform of the over-the-counter derivatives marketplace. The Committee’s bill is a significant step toward lowering risk and promoting transparency. Substantive challenges remain. I look forward to building on this Committee’s hard work with Chairman Frank, Chairman Peterson and others in the House and Senate to complete legislation that covers the entire marketplace without exception and to ensure that regulators have appropriate authorities to protect the public.”

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Release Date: October 15, 2009

Contact: Andrew DeSouza, (202) 962-7390, [email protected]

SIFMA’s Bentsen Statement on Committee Passage of Derivatives Regulation

October 15, 2009, Washington, DC—The Securities Industry and Financial Markets Association today released a statement from Ken Bentsen, Executive Vice President, Public Policy and Advocacy in response to the House Financial Services Committee’s passage of the Over-the-Counter Derivatives Markets Act of 2009.

“Bringing greater regulatory transparency and oversight to derivatives markets and products is a key component of reforming our financial system. That oversight must also recognize the important role these risk management tools play for countless companies across the country and for our broader economy. Mandating particular transaction modes, as this bill does, could raise transaction costs while not necessarily reducing risk in a commensurate amount—results that we believe are contrary to our shared reform goals. As the legislative process continues we look forward to working with the Congress toward a bill that strikes a balance between the need for transparency and risk management efficiency.”

The Securities Industry and Financial Markets Association brings together the shared interests of more than 550 securities firms, banks and asset managers. SIFMA’s mission is to promote policies and practices that work to expand and perfect markets, foster the development of new products and services and create efficiencies for member firms, while preserving and enhancing the public’s trust and confidence in the markets and the industry. SIFMA works to represent its members’ interests locally and globally. It has offices in New York, Washington D.C., and London and its associated firm, the Asia Securities Industry and Financial Markets Association, is based in Hong Kong.

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Other related hedge fund law articles:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, or if you have questions about investment adviser registration with the SEC or state securities commission, please call Mr. Mallon directly at 415-868-5345.

CTA and CPO Registration and Compliance Guide

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Practical guidance for CTA and CPO firms

Commodity Trading Advisors (CTAs) and Commodity Pool Operators (CPOs) have been contacting me with greater regularity and we have decided to provide those firms with more detailed information on their registration and compliance requirements. Over the course of the next few weeks we will be continually updating this page with more legal and business guidance for CTAs and CPOs. Specifically, we will be providing information on the following topics:

CTA and CPO Registration – this article discusses the how-to’s of registration with the CFTC. The article details the general requirements for firms, principals, and associated persons. Included in this discussion is information on CTA/CPO exam requirements and an overview of the registration process through the NFA’s electronic registration system.

CTA and CPO Registration Exemptions – while the Commodities Exchange Act will generally require CTA and CPO firms to register with the CFTC, there are some important exemptions from the registration provisions. Review this article to see if your firm might be able to claim an exemption from the registration provisions.

CTA and CPO Compliance Overview – CTAs and CPOs are subject to a number of laws, regulations and rules. Not only must CTAs and CPOs follow CFTC laws and regulations, but as Members of the NFA, these groups must also follow all of the rules developed by the NFA. We will be discussing compliance best practices, major examination issues, major deadlines and the CTA/CPO compliance manual. Being prepared for an NFA examination is of great importance.

Recent NFA Actions against CTA and CPO Managers – the NFA and the CFTC have been quite active lately. In this article we will be discussing some of the most recent actions against NFA member firms. This article will also provide common-sense advice on what managers can do the protect themselves from examination deficiencies.

Important NFA Rules for CTA and CPO Firms – there are a number of rules which the NFA has regarding the conduct of CTAs and CPOs. In general CTAs and CPOs must hold themselves out with the utmost professionalism. This article will detail this and other important NFA rules.

CTA and CPO advertising – there are a number of important rules regarding advertising for CTAs and CPOs. CPOs, especially, must be careful about advertising because of the restrictions under Rule 506 of Regulation D, an exemption that many CPOs utilize in offering their fund interests. Websites will be touched upon in this post and will also be discussed in greater depth in a subsequent posting.

CTA and CPO websites – many CTA firms utilize the internet to advertise their services. CPO firms will also sometimes have a (minimal) internet presence. This article will detail the considerations that both CTA and CPO firms face when creating and maintaining an internet presence and how to deal with internet based inquiries from potential investors.

NFA Exam Requirements for CTAs and CPOs – individuals of NFA member firms will generally need to have a Series 3 exam license and potentially a Series 30 exam. Some individuals may need to have a Series 31 exam license and, potentially in the future, forex CTAs and CPOs will need to have a Series 34 exam license. This article will discuss these exams and the process an individual will go through in order to register to take the exams.

CTA Expo Blog – the unofficial blog of the CTA Expo most recently held in October of 2009.  Information for CTA managers on business, legal and compliance issues.  Included is a directory of CTA firms and service providers.

Forex CTAs and CPOs – the regulatory light has been focused on retail spot forex managers recently. Read this article to get up to speed on recent CFTC and NFA pronouncements regarding this area of the industry. We will also provide information on Forex IBs and Forex FCMs.

In addition to the above topics we are hoping to add others over time. We welcome all feedback and encourage you to leave comments below. We will also attempt to answer CTA and CPO frequently asked questions.

If you are a manager or firm that needs to register as a CTA or CPO, or if you are contemplating registration, please contact Bart Mallon, Esq. of Cole-Frieman & Mallon LLP at 415-868-5345.

NFA Rule Compliance Rule 2-45 Approved

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CPOs Prohibited From Taking Loans From Commodity Hedge Funds

The CFTC just recently approved a new NFA compliance rule which prohibits commodity pool operators (CPOs) from taking loans from the commodity pools which they manage. Additionally, if a CPO currently has some sort of a loan arrangement with their fund, such CPO will have until October 22, 2009 to notify the NFA of the arrangement and surrounding facts and circumstances.

With regard to this new rule, we urge CPOs to take the following notes:

  • If you currently have a loan arrangement with your fund, please contact an attorney immediately. If you have such an arrangement and do not disclose this to the NFA within the allowed time frame, you will be subject to significant action in the future if it is found that you did not comply with this requirement.
  • CPOs should think about updating their commodity pool offering documents to include a discussion of this new prohibition (if it is not already discussed in the pool offering documents).
  • CPOs should update their compliance manuals and procedures to specifically address this issue – it is likely that this will be a specific examination item in the near future and a well prepared CPO should have procedures in place to ensure compliance.

Below we have reprinted the notice announcing the new rule as well as the interpretive release which provides color on the new rule. If you have any questions on this new rule and its applicability to you CPO or your commodity pool, please contact us.  Related article:

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Notice I-09-17

September 22, 2009

Effective Date of NFA Requirements Prohibiting Loans by Commodity Pools to CPOs and Related Entities

NFA has received notice that the Commodity Futures Trading Commission (“CFTC”) has approved new NFA Compliance Rule 2-45. This Rule and its accompanying Interpretive Notice, which both became effective September 11, 2009, prohibit commodity pools from making direct or indirect loans or advances of pool assets to the CPO or any other affiliated person or entity.

CPOs that currently have existing loan or advance arrangements between their pools and the CPO, the CPO’s principals, or related entities must notify NFA of these arrangements by October 22, 2009. The written notification to NFA should describe the reason for the loan or advance; indicate the interest the CPO is paying, if any; provide evidence that the loan or advance is secured by marketable, liquid assets; explain arrangements the CPO has made to pay back the loan or advance, if any; and include an executed copy of the loan or advance agreement. In addition, the CPO must provide NFA with written evidence that pool participants were informed about the loan or advance through a disclosure contained in the disclosure document, offering memorandum or other correspondence.

NFA will review the information provided to ensure, among other things, that participants received a full disclosure of the arrangements and that the loans and advances are secured by marketable liquid assets. Depending on the results of the review, NFA will determine if a CPO needs to take any additional steps regarding a particular loan or advance. NFA may also recommend disciplinary action if warranted by our review of the circumstances.

More information about NFA Compliance Rule 2-45, and the accompanying Interpretive Notice, can be found in NFA’s August 26, 2009 Submission Letter to the CFTC. Questions concerning these changes should be directed to Mary McHenry, Senior Manager, Compliance ([email protected] or 312-781-1420) or Tracey Hunt, Senior Manager, Compliance ([email protected] or 312-781-1284).

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August 26, 2009

Via Federal Express

Mr. David A. Stawick
Office of the Secretariat
Commodity Futures Trading Commission
Three Lafayette Centre
1155 21st Street, N.W.
Washington, DC 20581

Re: National Futures Association: Prohibition of Loans by Pools to Commodity Pool Operators and Related Parties – Proposed Adoption of Compliance Rule 2-45 and Interpretive Notice*

Dear Mr. Stawick:

On May 27, 2009, National Futures Association (“NFA”) submitted proposed new Compliance Rule 2-45 to the Commodity Futures Trading Commission (“CFTC” or “Commission”) for its review and approval. NFA hereby withdraws that submission and, pursuant to Section 17(j) of the Commodity Exchange Act, as amended, hereby resubmits the proposed Compliance Rule 2-45 and related Interpretive regarding prohibition of loans by pools to CPOs and related parties.

Compliance Rule 2-45 was approved by NFA’s Board of Directors (“Board”) on May 21, 2009, and the Interpretive Notice was approved by the Board on August 20, 2009. NFA is invoking the “ten-day” provision of Section 17(j) of the Commodity Exchange Act (“CEA”) and will make these proposals effective ten days after receipt of this submission by the Commission unless the Commission notifies NFA that the Commission has determined to review the proposals for approval.

PROPOSED AMENDMENTS
(additions are underscored)
COMPLIANCE RULES

* * *
PART 2 – RULES GOVERNING THE BUSINESS CONDUCT OF MEMBERS REGISTERED WITH THE COMMISSION
* * *

RULE 2-45. PROHIBITION OF LOANS BY COMMODITY POOLS TO CPOS AND AFFILIATED ENTITIES.

No Member CPO may permit a commodity pool to use any means to make a direct or indirect loan or advance of pool assets to the CPO or any other affiliated person or entity.

* * *
INTERPRETIVE NOTICES
* * *

COMPLIANCE RULE 2-45: PROHIBITION OF LOANS BY COMMODITY POOLS TO CPOS AND RELATED ENTITIES

NFA has recently taken a number of Member Responsibility Actions (MRAs) against commodity pool operators (CPOs) and CPO principals who directly or indirectly loaned or advanced pool assets to themselves or an affiliated person or entity. Many of these arrangements were used by these principals to purchase luxury items, while others went to related entities that did not have sufficient assets to repay the loans. In each case, the transaction resulted in significant losses to participants’ funds.

The Board of Directors has determined that direct or indirect loans or advances from pools to their CPOs, the CPO’s principals, or related entities should be prohibited. Therefore, NFA Compliance Rule 2-45 prohibits CPOs from permitting a commodity pool to use any means to make a direct or indirect loan or advance of pool assets to the CPO or any other affiliated person or entity.

NFA understands that a few pools may have made these types of loan or advance arrangements prior to Compliance Rule 2-45’s effective date. These CPOs are required to notify NFA of these existing arrangements within thirty (30) days of Compliance Rule 2-45’s effective date.

These arrangements violate NFA’s existing compliance rules if the arrangements are not consistent with the pool’s current disclosure document or offering materials and both the loan(s) or advance(s) and the conflict of interest are not fully disclosed to participants. Existing arrangements also violate NFA’s rules if the loan or advance is not secured by marketable, liquid assets (e.g. a CPO participant’s pro-rata interest in the pool’s liquid assets) and, therefore, the arrangement could have a material effect upon the pool’s ability to meet its obligations to participants.

EXPLANATION OF PROPOSED AMENDMENTS

In February, NFA took two Member Responsibility Actions (“MRAs”) against three NFA Member commodity pool operators (“CPOs”). Although the basis of both MRAs was the CPOs’ failure to cooperate with NFA in an investigation, the limited investigation that NFA was able to perform revealed that the CPOs had misappropriated pool funds through improper loans from pools to the CPOs or related entities. The CFTC charged all three of the CPOs with misappropriating pool assets through improper loans, and all three were charged criminally with fraud.

These two matters are not the first instances of CPOs misappropriating pool participant funds through direct or indirect loans from a pool to the CPO or a related entity. Over the years, there have been a number of regulatory actions involving this type of fraud. Given the significant losses suffered by pool participants as a result of these improper loans, NFA is proposing to prohibit direct or indirect loans from commodity pools to the CPO or any affiliated person or entity.

NFA staff discussed this matter with NFA’s CPO/CTA Advisory Committee, which supported prohibiting loans because it believes that absent extraordinary circumstances there is no legitimate reason for a pool to make a direct or indirect loan to its CPO or a related party.

At its May 2009 meeting, the Board approved Compliance Rule 2-45. Although the rule provides for a complete prohibition, the Board was somewhat concerned that there might be some unforeseen very limited circumstances where a carve-out to this prohibition would be appropriate. As a result, the Board instructed staff to handle these situations on a case-by-case basis, with the CPO seeking no-action relief from NFA.

After NFA submitted the proposed rule to the Commission for approval, Commission staff informed NFA that although they supported the overall concept, they had concerns regarding NFA’s granting of no-action relief. In light of the Commission’s concerns and the fact that there are few, if any, foreseeable situations in which NFA should permit a loan arrangement, the Board reconsidered its original position regarding no-action relief.

Nonetheless, the Board recognizes that there are a few loan arrangements currently in place that have been fully disclosed and are adequately collateralized. Therefore, the Interpretive Notice provides that CPOs will not be required to immediately sell other assets to repay these existing loans. CPOs will, however, be required to notify NFA of any such current arrangements within 30 days of Compliance Rule 2-45’s effective date. NFA will review these arrangements to ensure, among other things, that participants were provided with full disclosure of the arrangements and that the loans are secured by marketable, liquid assets. Moreover, as NFA has done in several recent MRAs, we will not hesitate to recommend disciplinary action if we find those loans involve fraud, inadequate disclosure or are not properly collateralized.

As mentioned earlier, NFA is invoking the “ten-day” provision of Section 17(j) of the Commodity Exchange Act. NFA intends to make proposed Compliance Rule 2-45 and the related Interpretive Notice regarding the prohibition of loans by pools to CPOs and related parties effective ten days after receipt of this submission by the Commission, unless the Commission notifies NFA that the Commission has determined to review the proposal for approval.

Respectfully submitted,

Thomas W. Sexton
Senior Vice President and
General Counsel
_________
* The proposed adoption of Compliance Rule 2-45 and Interpretive Notice became effective September 11, 2009.

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Other related hedge fund law articles include:

Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  If you are a hedge fund manager who is looking to start a hedge fund, or if you have questions about the CPO or CTA registration process, please call Mr. Mallon directly at 415-296-8510.

CFTC to Discuss Cap and Trade Regulation

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Carbon Emission Trading Likely to See Future Regulation

The Waxman-Markey cap and trade bill which was passed in Congress earlier this year (currently waiting for Senate approval) has had a number of interested parties discussing what cap and trade regulation in the U.S. will look like and how the various government agencies will regulate the new system.  The CFTC is jockeying for position to be the agency to regulate the carbon emission markets and the CFTC Advisory Comittee is meeting to discuss the manner in which the agency may regulate the markets.   We will report any news on this event and will continue to report how the cap and trade legislation will fit into the alternative investment industry and how it may affect hedge funds.

The CFTC press release is reprinted in full below and can be found here.

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Release: 5716-09
For Release: September 14, 2009

CFTC Advisory Committee to Discuss Energy and Environmental Markets

Committee to provide views on emissions trading markets and relevant energy issues.

Washington, DC – The Commodity Futures Trading Commission (CFTC or Commission) will convene the second meeting of its expanded Energy and Environmental Markets Advisory Committee (EEMAC) at 8:00 a.m. EDT, on Wednesday, September 16, 2009, at the CFTC’s New York Regional Office, 140 Broadway, 19th Floor, New York, NY 10005.

The Committee will focus on recent CFTC hearings on position limits and hedge exemptions, regulatory reform and legislative proposals, and carbon and other emissions trading markets.

Bart Chilton, the Committee’s Chair, stated that “As Congress once again takes up the important topic of cap and trade legislation, the issue of regulatory oversight in these markets becomes even more critical. The CFTC has a longstanding history of federal regulation of derivatives trading—from monitoring exchange activity to ensuring financial responsibility to carrying out disciplinary and enforcement actions, and it’s very important to have the federal oversight of the entire market as seamless as possible. These markets will be so big, and their impact so large, that the oversight needs to be done right—from the outset.”

The CFTC’s Division of Market Oversight will present an update on energy and environmental markets, the Office of Legislative Affairs will present an update on current legislation and several Committee members will present their views on specific issues. The Commission has invited staff from other federal agencies to attend as observers.

The meeting is open to the public. The meeting will be webcast via the internet and audio of the hearing will be available via a listen-only conference call. Individuals may also view the hearing via teleconference at the Commission’s headquarters in Washington, D.C., Three Lafayette Centre, 1155 21st Street, N.W.; and the Commission’s Chicago Regional Office, 525 West Monroe Street, Suite 1100.

What: Energy and Environmental Markets Advisory Committee Meeting

Location: CFTC New York Regional Office, Hearing Room, 140 Broadway, 19th Floor, New York, NY 10005

Date: September 16, 2009

Time: 8:00 a.m. – 11:00 a.m. EDT

Viewing/Listening Information:

The CFTC has made available the following options to access the hearing:

1. Watch a live broadcast of the meeting via Webcast on www.cftc.gov.

2. Call in to a toll-free telephone line to connect to a live audio feed.

Call-in participants should be prepared to provide their first name, last name, and affiliation. Conference call information is listed below:

Domestic Toll Free: (888) 691-4252
International Toll: (404) 537-3379
The conference ID: 20577008
Call leader name: Bart Chilton
Last Updated: September 14, 2009

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Bart Mallon, Esq. runs hedge fund law blog and has written most all of the articles which appear on this website.  Mr. Mallon’s legal practice is devoted to helping emerging and start up hedge fund managers successfully launch a hedge fund.  Mr. Mallon is also helps managers to register with the regulatory bodies including the SEC and CFTC.  If you are a hedge fund manager who is looking to start a hedge fund or if you need to register with the SEC or CFTC, please call Mr. Mallon directly at 415-296-8510.

Commodity Pool Operators Scrambling After Surprise CFTC Decision

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CFTC Withdraws Two No-Action Letters

In a surprise move the CFTC has withdrawn two no-action letters which is had just recently issued.  Under the new Chairman Gary Gensler, the CFTC has made an about face on this issue with regard to two commodity pool operators who were relying on the no-action letters issued in 2006.  Under the no-action letters, the CFTC provided no-action relief to the CPOs from certain speculative position limits.  According to the release reprinted below, the reason for the change is because Chairman Gensler “believe[s] that position limits should be consistently applied and vigorously enforced.”  While we generally believe that rules should be applied uniformly, we also believe that the governmental agencies (the CFTC and the SEC) should not make it a practice of revoking previously issued no-action letters.  We also believe that the CFTC and the SEC should not be in the business of express politicking, which may have been the case here – it sets a horrible precedent for new/changing administrations.  Additionally, we believe that the same “tough line” on position limits could have been effected in a less onerous manner.

The release states that the CFTC will work with the affected CPOs, but the damage has been done – how are businesses supposed to operate when these governmental agencies are constantly moving the target?

The no-action letters can be found here:

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Release: 5695-09
For Release: August 19, 2009

CFTC Withdraws Two No-Action Letters Granting Relief from Federal Speculative Position Limits on Soybeans, Corn and Wheat Contracts

Washington, DC – The U.S. Commodity Futures Trading Commission today announced that it is withdrawing two no-action letters that provided relief from federal agricultural speculative positions limits set forth in CFTC regulations (17 C.F.R §150.2).

“I believe that position limits should be consistently applied and vigorously enforced,” CFTC Chairman Gary Gensler said. “Position limits promote market integrity by guarding against concentrated positions.”

In CFTC Letter 06-09 (May 5, 2006), the agency’s Division of Market Oversight (DMO) granted no-action relief to DB Commodity Services LLC, a commodity pool operator (CPO) and commodity trading advisor (CTA), permitting the DB Commodity Index Tracking Master Fund to take positions in corn and wheat futures that exceed federal speculative position limits set forth in CFTC Regulation 150.2. Subsequently, in CFTC Letter 06-19 (September 6, 2006), DMO granted similar no-action relief to a CPO/CTA employing a proprietary commodity investment strategy that includes positions in Chicago Board of Trade corn, soybeans and wheat futures contracts. Among other things, DMO’s no-action position in both cases stated that any change in circumstances or conditions could result in a different conclusion. DMO has previously stated that the trading strategies employed by these entities would not qualify for a bona fide hedge exemption under the Commission’s regulations.

DMO will work with each of these entities as they transition to positions within current federal speculative limits. The withdrawal of these no-action positions is very specific and limited and does not affect any other no-action or regulatory positions taken by the CFTC or its staff with regard to these entities or other market participants.

Last Updated: August 19, 2009

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CFTC Proposes Reforms to Over-The-Counter Derivates Trading Regulation

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Statement of Gary Gensler Chairman, Commodity Futures Trading Commission

On June 4th, 2009, Gary Gensler, Chairman of the Commodity Futures Trading Commission, held a hearing before the Senate Committee on Agriculture, Nutrition and Forestry to address the importance of enacting broad reforms to regulate over-the-counter (OTC) derivates.  Gensler emphasized that such reforms must comprehensively regulate both derivative dealers and the markets in which derivatives trade in order to build and restore confidence in our financial regulatory system.  Below is a summary of the reforms proposed in CFTC hearing:

I.  Comprehensive Regulatory Framework

A comprehensive regulatory framework governing OTC derivative dealers and OTC derivative markets should apply to all dealers and all derivatives, no matter what type of derivative is traded or marketed. It should include interest rate swaps, currency swaps, commodity swaps, credit default swaps, and equity swaps. Further, it should apply to the dealers and derivatives no matter what type of swaps or other derivatives may be invented in the future. This framework should apply regardless of whether the derivatives are standardized or customized.

A new regulatory framework for OTC derivatives markets should be designed to achieve four key objectives:

1.  Lower systemic risks

  • Setting capital requirements for derivative dealers;
  • Creating initial margin requirements for derivative dealers (whether dealing in standardized or customized swaps);
  • Requiring centralized clearing of standardized swaps; and
  • Requiring business conduct standards for dealers.

2.  Promote the transparency and efficiency of markets

  • Requiring that all OTC transactions, both standardized and customized, be reported to a regulated trade repository or central clearinghouses;
  • Requiring clearinghouses and trade repositories to make aggregate data on open positions and trading volumes available to the public;
  • Requiring clearinghouses and trade repositories to make data on any individual counterparty’s trades and positions available on a confidential basis to the CFTC and other regulators;
  • Requiring centralized clearing of standardized swaps;
  • Moving standardized products onto regulated exchanges and regulated, transparent trade execution systems;
  • Requiring the timely reporting of trades and prompt dissemination of prices and other trade information

3.  Promote market integrity by preventing fraud, manipulation, and other market abuses, and by setting position limits

  • Providing CFTC with clear, unimpeded authority to impose reporting requirements and to prevent fraud, manipulation and other types of market abuses;
  • Providing CFTC with authority to set position limits, including aggregate position limits;
  • Moving standardized products onto regulated exchanges and regulated, transparent trade execution systems;
  • Requiring business conduct standards for dealers.

4.  Protect the public from improper marketing practices.

  • Business conduct standards applied to derivatives dealers regardless of the type of instrument involved;
  • Amending the limitations on participating in the OTC derivatives market in current law to tighten them or to impose additional disclosure requirements, or standards of care (e.g. suitability or know your customer requirements) with respect to marketing of derivatives to institutions that infrequently trade in derivatives, such as small municipalities

To best achieve these objectives, Gensler  recommends implementing two complementary regulatory regimes: one focused on the dealers that make the markets in derivatives and one focused on the markets themselves – including regulated exchanges, electronic trading systems and clearing houses.

II.  Regulating Derivatives Dealers

The current financial crisis has taught us that the derivatives trading activities of a single firm can threaten the entire financial system and that all such firms should be subject to robust Federal regulation. Specifically, all derivative dealers should be subject to capital requirements, initial margining requirements, business conduct rules and reporting and recordkeeping requirements. Standards that already apply to some dealers, such as banking entities, should be strengthened and made consistent, regardless of the legal entity where the trading takes place.

 II (a). Capital and Margin Requirements

 The Congress should explicitly require regulators to promulgate capital requirements for all  derivatives dealers. Imposing prudent and conservative capital requirements, and initial margin  requirements, on all transactions by these dealers will help prevent the types of systemic risks  that AIG created. No longer would derivatives dealers or counterparties be able to amass large  or highly leveraged risks outside the oversight and prudential safeguards of regulators.

 II (b).  Business conduct and Transparency Requirements

 Business conduct standards should include measures to both protect the integrity of the market  and lower the risk (both counterparty and operating) from OTC derivatives transactions.

 To promote market integrity, the business conduct standards should:

  • Include prohibitions on fraud, manipulation and other abusive practices
  • Require adherence to position limits established by the CFTC on OTC derivatives that perform or affect a significant price discovery function with respect to regulated markets
  • Ensure the timely and accurate confirmation, processing, netting, documentation, and valuation of all transactions.
  • Require derivatives dealers to be subject to recordkeeping and reporting requirements for all of their OTC derivatives positions and transactions, including retaining a complete audit trail and mandated reporting of any trades that are not centrally cleared to a regulated trade repository
  • Provide transparency of the entire OTC derivates market by making this information available to all relevant federal regulators and making aggregated information on positions and trades available to the public
  • Provide clear authority for regulating and setting standards for trade repositories to ensure that the information recorded meets regulatory needs and the repositories have strong business conduct practices

III.  Regulating Derivates Markets

All derivatives that can be moved into central clearing should be required to be cleared through regulated central clearing houses and brought onto regulated exchanges or regulated transparent electronic trading systems.  Requiring clearing and trading on exchanges or through regulated electronic trading systems will promote transparency and market integrity and lower systemic risks.  To fully achieve these objectives, both of these complementary regimes must be enacted – Regulating both the traders and the trades will ensure that we cover both the actors and the actions that may create significant risks. To regulate both derivates and the market itself, the following areas need to be regulated:

a) Central clearing
b) Exchange-trading
c) Position limits
d) Standardized and customized derivates
e) Authority

III (a).  Central Clearing

Central clearing should help reduce systemic risks in addition to the benefits derived from  comprehensive regulation of derivatives dealers. Clearing reduces risks by facilitating the netting  of transactions and by mutualizing credit risks. Currently, most of the contracts entered into in  the OTC derivatives market are not cleared, and remain as bilateral contracts between individual  buyers and sellers. In contrast, when a contract between a buyer and seller is submitted to a  clearinghouse for clearing, the contract is “novated” to the clearinghouse. This means that the  clearinghouse is substituted as the counterparty to the contract and then stands between the  buyer and the seller.

Clearinghouses then guarantee the performance of each trade that is submitted for clearing.  Clearinghouses use a variety of risk management practices to assure the fulfillment of this  guarantee function. Foremost, derivatives clearinghouses would lower risk through the daily  discipline of marking to market the value of each transaction.

The regulations applicable to clearing should require central clearinghouses to:

  • Establish and maintain robust margin standards and other necessary risk controls and measures
  • Have transparent governance arrangements that incorporate a broad range of viewpoints from members and other market participants
  • Have fair and open access criteria that allow any firm that meets objective, prudent standards to participate regardless of whether it is a dealer or a firm
  • Implement rules that allow indirect participation in central clearing

III (b).  Exchange-Trading

Market transparency and efficiency would be further improved by moving the standardized part  of the OTC markets onto regulated exchanges and regulated transparent electronic trading  systems.  Furthermore, a system for the timely reporting of trades and prompt dissemination of  prices and other trade information to the public should be required. Both regulated exchanges  and regulated transparent trading systems should allow market participants to see all of the bids  and offers. A complete audit trail of all transactions on the exchanges or trade execution   systems should be available to the regulators. Through a trade reporting system there should be  timely public posting of the price, volume and key terms of completed transactions.

III (c).  Position Limits

Position limits must be applied consistently all markets, across all trading platforms, and  exemptions to them must be limited and well defined.  The CFTC should have the ability to  impose position limits, including aggregate limits, on all  persons trading OTC derivatives that  perform or affect a significant price discovery function with respect to regulated markets. Such  position limit authority should clearly empower the CFTC to establish aggregate position limits  across markets in order to ensure that traders are not able to avoid position limits in a market  by moving to a related exchange or market. Gensler anticipates that this new authority will  better enable the CFTC to protect the integrity of the price discovery process in the futures  markets and protect the public against fraud, manipulation and other abuses. 

III (d).  Standardized and Customized Derivatives

It is important that tailored or customized swaps that are not able to be cleared or traded on an  exchange be sufficiently regulated. Regulations should also ensure that customized derivatives  are not used solely as a means to avoid the clearing requirement. Genlser proposes that the  CFTC accomplish this in two ways:

  1. Regulators should be given full authority to prevent fraud, manipulation and other abuses and to impose recordkeeping and transparency requirements with respect to the trading of all swaps, including customized swaps.
  2. Ensure that dealers and traders cannot change just a few minor terms of a standardized swap to avoid clearing and the added transparency of exchanges and electronic trading systems

Additional criteria for consideration in determining whether a contract should be considered to  be a standardized swap contract should include:

  • The volume of transactions in the contract
  • The similarity of the terms in the contract to terms in standardized contracts
  • Whether any differences in terms from a standardized contract are of economic significance
  • The extent to which any of the terms in the contract, including price, are disseminated to third parties

III (e).  Authority

Lastly, to achieve the goals described above, the Commodity Exchange Act should be amended  to provide the CFTC with positive new authority to regulate OTC derivatives. The term “OTC  derivative” should be defined, and the CFTC should be given clear authority over all such  instruments. To the extent that specific types of OTC derivatives might best be regulated by  other regulatory agencies, care must be taken to avoid unnecessary duplication and overlap.
 As new laws and regulations are enacted, the CFTC should be careful not to call into question  the enforceability of existing OTC derivatives contracts. New legislation and regulations should  not provide excuses for traders to avoid performance under pre-existing, valid agreements or to  nullify pre-existing contractual obligations.

IV.  Conclusion

It is clear that we need the same type of comprehensive regulatory reform today. Today’s regulatory reform package should cover all types of OTC derivatives dealers and markets. It should provide the CFTC and other federal agencies with full authority regarding OTC derivatives to lower risk; promote transparency, efficiency, and market integrity and to protect the American public.

Today’s complex financial markets are global and irreversibly interlinked. We must work with our partners in regulating markets around the world to promote consistent rigor in enforcing standards that we demand of our markets to prevent regulatory arbitrage.