On February 9, 2012, the Commodity Futures Trading Commission (CFTC) issued a final rule regarding changes to Part 4 of the Commission's regulations involving registration and compliance obligations for commodity pool operators (CPOs) and commodity trading advisors (CTAs). The rule is divided into changes to Rule 4.5 (relevant to mutual funds and other registered investment companies), Rule 4.13(a)(4) (rescinding a CPO exemption widely used by managers of 3(c)(7) funds), and Rule 4.27 (imposing new reporting obligations).

Rule 4.5: Trading Threshold and Marketing Test Criteria Have Been Added Back

The CFTC adopted final regulations with respect to most of its earlier proposal to amend Rule 4.5, and issued proposed regulations to harmonize the CFTC's rules with those of the Securities and Exchange Commission (SEC), where the two regulatory schemes were different or conflicted. The CFTC has requested public comment on its proposed rules.

Prior to 2003, Rule 4.5 had two substantive limitations that registered investment companies (RICs) had to satisfy - that less than 5 percent of the fund's assets are used as initial margin for futures trading and that the fund not be marketed as a futures fund. In 2003, the CFTC removed those limitations, opening the door for RICs to develop managed futures products without CFTC registration or regulation.

After the NFA petitioned the CFTC in August 2010 to do so, the CFTC in January 2011 proposed to amend Rule 4.5 to reinstate the trading threshold and marketing test criteria. (Funds that could not satisfy those limitations would not be able to claim Rule 4.5 relief and would be subject to the CFTC rules for retail commodity pools.)

Trading Threshold

The CFTC adopted the proposed threshold that derivatives trading in a Rule 4.5 fund could not exceed 5 percent of such fund's liquidation value. While margin for bona fide hedging purposes is excluded, the 5 percent limit includes all derivative trading, including swaps. The CFTC's final rule also declined to differentiate between active and passive use of futures. Thus, RICs that use futures to replicate an index fund or to simulate equity exposure would be subject to the trading threshold.

The CFTC reversed its earlier position and adopted a "net notional test" as an alternative trading threshold. Entities can claim the Rule 4.5 relief if the aggregate net notional value of the entity's derivative positions does not exceed the liquidation value of the fund. Futures can be netted across exchanges, whereas swaps can be netted only if cleared by the same designated clearing organization.

Marketing Restriction

The CFTC proposed that Rule 4.5 entities are prohibited from marketing the fund "as a vehicle for trading in (or otherwise seeking investment exposure to) commodity futures, options or swaps markets." In its final rule, the CFTC omitted the parenthetical language, citing its ambiguous nature. The final rule lists seven factors that the staff will consider in determining whether a Rule 4.5 fund has met the marketing restriction. The staff clarified that no single factor would be dispositive, rather all factors would be considered.

The seven factors that the staff will consider are:

  • The name of the fund;
  • Whether the fund's primary investment objective is tied to a commodity index;
  • Whether the fund makes use of a controlled foreign corporation for its derivatives trading;
  • Whether the fund's marketing materials, including its prospectus or disclosure document, refer to the benefits of the use of derivatives in a portfolio or make comparisons to a derivatives index;
  • Whether, during the course of its normal trading activities, the fund or entity on its behalf has a net short speculative exposure to any commodity through a direct or indirect investment in other derivatives;
  • Whether the futures/options/swaps transactions engaged in by the fund or on behalf of the fund will directly or indirectly be its primary source of potential gains and losses; and
  • Whether the fund is explicitly offering a managed futures strategy.


The CFTC acknowledged that as a result of the revised Rule 4.5, the CFTC will need to harmonize its rules with the SEC's requirements for RICs. The CFTC proposed a number of rule changes to temper or eliminate conflicts with the SEC's rules and solicited industry input on better ways to harmonize the CFTC's rules with those of the SEC. Proposals for Harmonization The CFTC proposed various rules that would provide solutions to deal with those areas where CFTC and SEC rules are not aligned or even conflict with one another. Some of the conflicts are substantive — such as whether disclosure of past performance of the CPO and the advisor is required or prohibited — whereas other conflicts relate to where in the disclosure document a particular disclosure is required to be.

In this regard, the CFTC has proposed to:

  • allow RICs to make past performance disclosures required under the CFTC rules in the statement of additional information;
  • allow RICs to disclose the CFTC's break-even point following the summary prospectus;
  • require any fees or expenses that are not disclosed in the fee table to be included in the prospectus;
  • revise the updating schedule for CPOs from nine months to 12 months to coincide with the SEC's schedule;
  • allow CPOs to distribute amendments to their disclosure documents to their participants at the same time as the document is filed with the National Futures Association (NFA); and
  • continue to require the distribution of periodic reports to participants (normally monthly) even though not required by the SEC.

The CFTC has sought public comment on these proposals and solicited industry comments as to better ways to achieve the harmonization.

If a RIC is Not Eligible to Rely on Revised Rule 4.5, Which Entity Will Register as a CPO?

Under CFTC rules, a CPO is the sponsor (such as a general partner) of the fund. Since RICs typically are organized as trusts, it was not apparent who would be required to register as the CPO. The CFTC has agreed with the NFA's suggestion that the RIC's investment advisor is the most logical entity to be the CPO.

Use of Controlled Foreign Corporation

It is common for RICs to obtain their futures exposure by investing a portion of its assets in a foreign subsidiary where the futures trading will occur. Under the Internal Revenue Code, such a subsidiary is deemed to be a "controlled foreign corporation." The CFTC did not object to the use of the foreign subsidiary, but concluded that if the controlled foreign corporation met the statutory definition of a commodity pool, the CPO of such entity, unless otherwise exempt, would have to register as a CPO.

Implementation of Rule 4.5 Amendments

The CFTC bifurcated the effective date for its Rule 4.5 amendments. For purposes of CPO registration only, the effective date is the later of December 31, 2012, or within 60 days following the adoption of final rules defining the term "swap" and establishing margin requirements for such instruments. For those entities required to register, the effective date for compliance with the CFTC's other Part 4 rules is within 60 days after the effective date of the final rule regarding the harmonization of the CFTC and SEC rules referenced in the current proposed rulemaking.

Rule 4.27 and Forms CPO-PQR and CTA-PR

The CFTC has adopted Rule 4.27, which requires CPOs and CTAs to report certain information to the Commission on Forms CPO-PQR and CTA-PR, respectively. The Commission's new reporting requirements supplement SEC reporting requirements for dual registrants that must file Form PF with the SEC by virtue of their dual registration status. CPOs that are dually registered with the SEC and that file Form PF must still file Schedule A of Form CPO-PQR with the Commission, and CTAs must still file Form CTA-PR.


All registered CPOs will be required to complete Schedule A of Form CPO-PQR. A registered CPO with assets under management equal to or greater than $150 million (mid-size CPOs) will also be required to complete Schedule B of the Form. CPOs with assets under management equal to or greater than $1.5 billion (large CPOs) will be required to complete Schedules A, B and C of the Form. Schedule A seeks basic identifying information about the CPO, each of its pools, and any service providers used. Schedule B, which mid-size CPOs and large CPOs will be required to complete, will solicit data about each pool operated by these CPOs. Schedule C requests information about the pools operated by large CPOs on an aggregated and pool-by-pool basis.

As adopted, all CPOs, other than large CPOs, will be required to file Schedule A on an annual basis, within 90 days of the end of the calendar year. Mid-size CPOs will be required to file Schedule B on an annual basis, within 90 days of the end of the calendar year. Large CPOs will be required to file Schedules A, B, and C on a quarterly basis, within 60 days of the end of the calendar quarter.


The Commission has decided to adopt only Schedule A of Form CTA-PR and will add a question asking the reporting CTA to identify the pools under its advisement so that the Commission can analyze the relationships among the various registrants to better assess sources of risk to the market and measure their potential reach. Because Form CTA-PR will be limited to demographic data, the Commission has determined that CTAs file the form on an annual basis within 45 days of the end of the fiscal year.


The effective date for Rule 4.27 and Forms CPO-PQR and CTA-PR is July 2, 2012. The Commission is adopting a two-stage phase-in period for compliance with Form CPO-PQR filing requirements. The compliance date for Rule 4.27 is September 15, 2012 for any CPO having at least $5 billion in assets under management attributable to commodity pools as of the last day of the fiscal quarter most recently completed prior to September 15, 2012. For all other registered CPOs and all CTAs, the compliance date for Rule 4.27 is December 15, 2012.

Rescission of Rule 4.13(a)(4)

The CFTC has rescinded the exemption from registration as a CPO in Rule 4.13(a)(4) effective as of December 31, 2012. Previously, Rule 4.13(a)(4) exempted pool operators from registration as CPOs so long as they offered interests in their pools only to certain highly qualified individuals and entities. The CFTC did not provide relief for family offices or fund-of-fund managers, nor did it "grandfather" in existing Rule 4.13(a)(4) exempt CPOs.

Existing CPOs relying on Rule 4.13(a)(4) have until December 31, 2012 to either 1) rely on a different exemption from registration or 2) register with the CFTC and become a member of the NFA.

The CFTC did not rescind the exemption from registration as a CPO in Rule 4.13(a)(3). Rule 4.13(a)(3) exempts pool operators from registration as CPOs so long as they restrict their futures and swap trading to certain de minimis levels. Additionally, the Rule 4.7 exemption remains – however, Rule 4.7 provides relief only from certain disclosure and compliance obligations, whereas Rule 4.13 exempts CPOs from registration altogether.

Additionally, CPOs relying on Rule 4.13(a)(3) (along with CPOs and CTAs relying on exemptions from registration under CFTC Rules 4.5, 4.13, or 4.14) will need to file annual exemption renewals with NFA.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.