The US Commodity Futures Trading Commission has proposed amendments to CFTC Regulation 3.10(c)(3) to allow non-US commodity pool operators to claim an exemption from registration with respect to their offshore commodity pools on a pool-by-pool basis.
At an open meeting on May 28, 2020, the US Commodity Futures Trading Commission (CFTC) approved for publication a proposal (Proposal) to amend Regulation 3.10(c)(3) to provide an exemption from registration for foreign persons acting as commodity pool operators (non-US CPOs) on behalf of offshore commodity pools with non-US participants that trade in US derivatives markets (Offshore Commodity Pools), subject to certain conditions. The proposed amendments are designed to provide regulatory flexibility for non-US CPOs operating Offshore Commodity Pools by taking into account the global nature of their operations without compromising the CFTC’s mission of protecting US pool participants.
In this regard, the Proposal would
CFTC Regulation 3.10(c)(3) provides an exemption from CPO registration to any person engaged in the activity of a CPO in connection with any commodity interest transaction executed in the United States (whether bilaterally or on or subject to the rules of any designated contract market or swap execution facility), so long as
The CFTC has clearly stated that the prohibition on contact with US persons applies to solicitation of customers as well as acceptance of orders. Consequently, CPOs are prohibited from relying on the CFTC Regulation 3.10(c)(3) exemption with respect to their Offshore Commodity Pools and another exemption from registration or exclusion with respect to their other commodity pools.
In 2018, the CFTC proposed to codify relief in CFTC Advisory 18-96, available to certain registered CPOs, including those who operate a commodity pool that (1) is organized and operated outside the United States; (2) does not hold meetings or conduct administrative activities within the US CPOs; (3) does not have any US person shareholders or other US person participants; and (4) does not receive, hold, or invest any capital directly or indirectly contributed from sources within the United States.
In addition, the CPO, its pool, and any person affiliated therewith may not undertake any marketing activity for the purpose, or that could reasonably be expected to have the effect, of soliciting participation from US persons. Advisory 18-96 provides relief from the disclosure, reporting, and recordkeeping requirements of CFTC Regulations 4.21, 4.22, and 4.23(a)(10) and (a)(11). However, after receiving public comment on this proposal, the CFTC withdrew the proposal in 2019 and instead analyzed whether the CFTC Regulation 3.10 exemption should be amended to achieve the Commission’s goals and to respond to issues articulated by commenters.
The Proposal would amend CFTC Regulation 3.10(c)(3) to permit a non-US CPO to rely on the exemption as long as all of the participants in a given offshore pool are located outside of the United States. As proposed, CFTC Regulation 3.10(c)(3)(ii) would be available to a non-US CPO acting in connection with any commodity interest transactions that are executed bilaterally or on or subject to the rules of any designated contract market or swap execution facility, so long as
Similar to the current exemption, the Proposal does not require a non-US CPO to make a filing to claim the exemption.
The Proposal would be helpful to a number of registered CPOs who currently must identify Offshore Commodity Pools to the National Futures Association and who typically rely on CFTC Advisory 18-96 with respect to these pools. Now, a registered non-US CPO will be able to claim relief with respect to the operation of their Offshore Commodity Pools. As a result, such a non-US CPO will not be subject to Form CFTC-PQR reporting requirements that are otherwise currently applicable to the Offshore Commodity Pools.
Importantly, under the Proposal, a non-US CPO’s reliance on CFTC Regulation 3.10(c)(3) would not preclude the non-US CPO from claiming other exemptions or exclusions, including those in CFTC Regulations 4.5 or 4.13.
As noted above, the proposed amendments to CFTC Regulation 3.10(c)(3) would include the condition that the non-US CPO claiming the relief be acting only on behalf of persons located outside the United States and its territories or possessions. However, the nature of some Offshore Commodity Pools, which are traded in offshore secondary markets, may make it difficult for some non-US CPOs to make a representation as to investor status with any certainty, even when their Offshore Commodity Pools are not marketed or intended for sale to US persons.
To address this uncertainty and provide additional flexibility for non-US CPOs, the CFTC proposed to add new CFTC Regulation 3.10(c)(3)(iv). Under this new provision, the Proposal would introduce a safe harbor pursuant to which a CPO that has taken reasonable steps designed to ensure that participation units in the offshore pool are not being offered or sold to US persons may avail itself of the CFTC Regulation 3.10(c)(3)(iv) exemption.
To rely on the newly proposed safe harbor, a non-US CPO must comply with all the following conditions:
The CFTC noted that the absence of US participants is sufficiently ensured so as to allow a non-US CPO that satisfies these conditions to rely on the exemption from registration provided by CFTC Regulation 3.10(c)(3).
In addition to the “stacking” of exemptions and providing a safe harbor for reliance on CFTC Regulation 3.10(c)(3), the CFTC has proposed to exclude a non-US CPO’s US controlling affiliate from the definition of a pool “participant,” to the extent that the US controlling affiliate makes an initial capital contribution to an Offshore Commodity Pool. The Proposal defines “control” to mean “the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting shares, by contract, or otherwise.”
Although the CFTC generally focuses its resources on protecting US investors, the CFTC noted that a controlling affiliate’s control over its non-US CPO affiliate “should provide a meaningful degree of protection and transparency with respect to the controlling affiliate’s contribution of initial capital to the non-U.S. CPO’s offshore commodity pool.”
The proposed relief for US controlling affiliate capital contributions is limited to those contributions made at or near an Offshore Commodity Pool’s inception. The CFTC emphasizes that the proposed relief may not be used to evade the CFTC’s CPO compliance requirements with respect to Offshore Commodity Pools. Accordingly, the proposed relief prohibits the interests in the US control affiliate from being “marketed as providing access to trading in commodity interest markets in the U.S., its territories or possessions.”
This proposed relief is similar to no-action relief in CFTC Staff Letter 15-46, excluding initial capital contributions provided to offshore pools operated by a non-US CPO derived from the US employees of the affiliated US investment advisers to the offshore pools. While this no-action relief generally required a CPO to redeem an employee’s investment within two years of the seed capital investment in the fund, the Proposal does not impose any redemption requirement or time limitation.
The Proposal is a long time coming, and would provide practical relief to non-US CPOs that operate Offshore Commodity Pools. The CFTC has requested comments on all aspects of the proposal and specifically requested comments regarding potential evasion of CPO regulation through the use of the controlling affiliate initial capital contribution provision.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:
Michael M. Philipp
Thomas V. D’Ambrosio