I. Introduction
The Commodity Futures Trading Commission (CFTC or Commission) recently proposed amendments to CFTC Regulation 4.7 (the Proposed Rule) that would impact long-standing exemptions from certain compliance requirements for commodity pool operators (CPOs) and commodity trading advisors (CTAs).1 The CFTC prepared the Proposed Rule to “update” Regulation 4.7 “after a careful review of the existing language and structure of Regulation 4.7, and considering the clear public and regulatory interest of maintaining and modernizing older, but still widely utilized provisions.”2 The public comment period will close 60 days after publication of the Proposed Rule in the Federal Register.
Existing Regulation 4.7 is widely used by market participants. The CFTC reports that based on National Futures Association (NFA) Form PQR Q4 2022 data, 837 registered CPOs operated approximately 4,304 commodity pools pursuant to claimed Regulation 4.7 exemptions and approximately 865 CTAs claimed an exemption under Regulation 4.7 for their trading programs.
In addition to the Commission seeking comments on the Proposed Rule, and the questions posed in the Proposed Rule, Commissioner Summer Mersinger asked 10 questions in her dissenting statement and encouraged commenters to address her specific questions in their responses.3 Related, Commissioner Caroline Pham, in a concurring statement, raised concerns that the proposed changes are “burdensome and unnecessary for entities that are already subject to extensive CFTC regulation or banking, securities, insurance, or other financial services regulation.”4
This alert provides a brief explanation of the Proposed Rule’s primary components. Click here for a redline that shows the proposed changes.
Please contact a member of the WilmerHale Futures & Derivatives Group for more information.
II. Proposed Amendments to CFTC Regulation 4.7
The Proposed Rule has three main changes, each described below.
A. Updating Financial Thresholds in the Portfolio Requirement of the Qualified Eligible Person (QEP) Definition
The Proposed Rule would increase Regulation 4.7’s “Portfolio Requirement” dollar-based thresholds for the first time since its original adoption in 1992. The CFTC proposes to raise the securities and other investments test from $2 million to $4 million and the initial margin and option premiums test from $200,000 to $400,000.
The CFTC justifies these new thresholds based on inflation indexes to determine a monetary threshold in Regulation 4.7(a) that would “indicate the high level of investor sophistication, acumen, and resources that the [CFTC] intended when [Rule 4.7(a)] was adopted.”5 In her concurring statement, Commissioner Kristin Johnson noted that she “do[es] not find the amended portfolio requirement to be too restrictive or limiting today, more than 30 years later” and suggest that “[p]erhaps the thresholds could be higher.”6
B. Establishing Minimum Disclosure Requirements Under Regulation 4.7
The Proposed Rule seeks to implement certain minimum disclosures to CPOs’ and CTAs’ prospective and actual QEP pool participants and advisory clients, respectively. The CFTC cites the “significant expansion and growth in the complexity and diversity of commodity interest products offered to QEPs via 4.7 pools and trading programs, as well as an expansion in the asset classes subject to the Commission’s jurisdiction and oversight,”7 including the size of swaps markets and the introduction of new and complex commodity interest products.
The CFTC states the amendments are intended to
- Recognize the increasingly complex and diverse commodity interest investment products offered to QEPs today and reflect the resulting evolution in view by the Commission that requiring basic disclosures to encourage informed investment decisions is the necessary and preferred approach for 4.7 pools and trading programs;
- Create a formalized Commission regulatory regime for promotional, advertising and disclosure practices for CPOs and CTAs relying on Regulation 4.7 with respect to their QEP offerings, allowing prospective and current participants and clients to better compare strategies, fees, and other characteristics of 4.7 pools and trading programs through consistent QEP disclosures; and
- Strengthen intermediary oversight by incorporating the review of QEP disclosures into existing examination processes used by the Commission and NFA, which, in turn, would increase their accuracy and quality over time.8
The Proposed Rule would require certain information by CPOs with respect to exempt pools, including that an offering memorandum distributed in connection with soliciting prospective participants in the exempt pool be distributed consistent with Regulation 4.21 and include, among other things:
- a description of principal risk factors;
- a description of the investment program and use of proceeds (for a CPO) or trading program (for a CTA);
- a description of fees and expenses;
- a description of conflicts of interest;
- performance disclosures; and
- disclosure that the exempt pool’s offering memorandum or the commodity trading advisor’s trading program brochure or account document is not filed with the CFTC and the CFTC does not evaluate the materials.
Finally, the Proposed Rule would amend the provision in Regulation 4.7(b)(3) that permits CPOs to distribute account statements no less frequently than quarterly within 30 days after the end of the reporting period. As the CFTC describes, CPOs of 4.7 pools that are funds of funds have reported difficulty complying with the quarterly reporting requirement, and they regularly request and receive exemptive letters from the Commission to permit them to follow an alternate account statement schedule, namely permitting the CPO to distribute monthly rather than quarterly account statements for their 4.7 funds-of-funds pools within 45 days of the month-end.
The Proposed Rule would codify the relief granted in exemptive letters, resulting in a rule that would allow the CPOs of 4.7 pools that are funds of funds to distribute monthly account statements within 45 days of the month-end, provided that a CPO notifies its QEP pool participants so they are aware of the schedule for the distribution of account statements.
