At an open meeting on October 15, 2020, the Commodity Futures Trading Commission (CFTC) adopted a final rule (Final Rule) amending CFTC Regulation 3.10(c), clarifying exemptive relief 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) and providing additional relief for foreign persons acting in the capacity of a futures commission merchant (FCM), introducing broker (IB), commodity trading advisor (CTA), or commodity pool operator (CPO) (collectively, Foreign Intermediaries). The Final Rule was adopted substantially as proposed, although, as discussed below, the CFTC tailored portions of the proposal in response to comments received.
Prior to the adoption of the Final Rule, CPOs that wished to avail themselves of the exemption from registration offered by CFTC Regulation 3.10(c)(3) were subject to a number of limitations, including the inability to be registered as a CPO and rely on this exemption or to “stack” this exemption with other exemptions. In addition, prior to the Final Rule, the CFTC’s regulations did not provide a safe harbor for the inadvertent inclusion of US investors in Offshore Commodity Pools or permit a US affiliate of a non-US CPO to invest seed capital in an Offshore Commodity Pool.
With the adoption of the Final Rule, the CFTC provides regulatory flexibility for non-US CPOs that operate Offshore Commodity Pools by taking into account the global nature of their operations without compromising the CFTC’s mission of protecting US investors.
In this regard, the Final Rule accomplishes the following:
The Final Rule amends 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 an Offshore Commodity Pool are located outside of the United States. The exemption is self-executing. As amended, CFTC Regulation 3.10(c)(3)(ii) provides exemptive relief to a non-US CPO acting in connection with any commodity interest transactions that are executed bilaterally or subject to the rules of any designated contract market or swap execution facility, so long as:
Prior to the adoption of the Final Rule, CPOs that operated Offshore Commodity Pools alongside other commodity pools with US investors were required to identify to the National Futures Association and report on Form CPO-PQR their Offshore Commodity Pools pursuant to CFTC Advisory 18-96.
Under the Final Rule, a non-US CPO that is registered as a CPO will be able to claim exemptive relief with respect to the operation of its Offshore Commodity Pools. As a result, the non-US CPO will no longer be subject to Form CPO-PQR reporting requirements with respect to the Offshore Commodity Pools.
Importantly, under the Final Rule, 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, or from claiming the CFTC Regulation 3.10(c)(3) exemption while operating other pools pursuant to CPO registration.
Safe Harbor With Respect to Inadvertent US Participants in Offshore Pools
As noted above, the amendments to CFTC Regulation 3.10(c)(3) include the condition that the non-US CPO claiming the relief with respect to an Offshore Commodity Pool act only on behalf of persons located outside the United States, its territories, or possessions. The CFTC recognizes that the nature of some Offshore Commodity Pools which may be traded in offshore secondary markets (e.g., Undertakings for the Collective Investment in Transferable Securities or UCITS funds) 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 has adopted a non-exclusive safe harbor that allows a CPO to avail itself of the CFTC Regulation 3.10(c)(3) exemption if it has taken reasonable steps designed to ensure that participation units in the Offshore Commodity Pool are not being offered or sold to US persons.
To rely on this safe harbor, a non-US CPO must comply with all of the following conditions:
Affiliate Initial Capital Contribution Exception
In addition to the “stacking” of exemptions and new safe harbor, the CFTC has adopted amendments to exclude a non-US CPO’s US affiliate from the definition of pool “participant,” to the extent that the US affiliate makes an initial capital contribution to an Offshore Commodity Pool. As proposed, the amendment would have explicitly required that the US affiliate be a controlling affiliate of the Offshore Commodity Pool. However, after further consideration of the proposal and the comments received, the CFTC removed this requirement from the Final Rule. The CFTC explained:
“The definition of ‘affiliate’ in Commission regulation 4.7(a)(1)(i) already incorporates the idea of ‘control,’ which is substantively identical to that in Commission regulation 49.2(a)(4). Therefore, as noted by commenters, control is already required between or among related entities for those entities to be considered ‘affiliates’ under Commission regulation 4.7(a)(1)(i), as ‘control’ is inherent to that ‘affiliate’ definition.”
The relief for US affiliate capital contributions is limited to those contributions made by affiliated entities (not natural persons) at or near an Offshore Commodity Pool’s inception. Unlike CFTC No-Action Relief Letter No. 15-46—which provides CPO registration relief to a non-US CPO notwithstanding capital contributions of a US-affiliated investment adviser’s employees to Offshore Commodity Pools operated by the non-US CPO—the Final Rule does not impose a requirement that the capital contribution be redeemed within two years of the investment. Furthermore, the relief is only available to those entities that are not “barred or suspended from participating in the commodity interest markets in the United States, its territories or possessions.” The CFTC emphasizes that the relief may not be used to evade the CFTC’s CPO compliance requirements with respect to Offshore Commodity Pools, and the relief prohibits interests in the US affiliate from being “marketed as providing access to trading in commodity interest markets in the US, its territories or possessions.”
In addition to adopting relief for non-US CPOs, the CFTC also finalized amendments to CFTC Regulation 3.10(c) that were originally proposed in 2016 (2016 Proposal). The 2016 Proposal sought to exempt from registration foreign persons acting as intermediaries with respect to commodity interest transactions for persons (i) located outside of the United States, or (ii) who are IFIs without regard to whether such foreign persons clear the transactions.
The Final Rule adopts the 2016 Proposal with two modifications. First, the Final Rule provides that the exemption from registration available to Foreign Intermediaries pursuant to CFTC Regulation 3.10(c) is conditioned on any commodity interest transaction that is required to be cleared on a registered derivatives clearing organization (DCO) is in fact cleared on a DCO by a registered FCM, unless the Foreign Intermediary’s customer is a clearing member of the relevant DCO. Second, the CFTC is expanding the definition of IFI to be consistent with the terms in the recently adopted Cross-Border Swap Rule.
The Final Rule will provide practical relief to many non-US CPOs that are currently registered with the CFTC as CPOs, who should begin to analyze whether they can delist their Offshore Commodity Pools. Upon delisting these pools, non-US CPOs will no longer need to file Advisory 18-96 notices or include their Offshore Commodity Pools in their Form CPO-PQR filings. The Final Rule takes effect 60 days after it is published in the Federal Register.
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
 See Exemption From Registration for Certain Foreign Persons, 81 Fed. Reg. 51824 (Aug. 5, 2016). For purposes of the 2016 Proposal, the CFTC defined IFIs as those multinational institutions defined in the CFTC’s previous rulemakings and staff no-action letters, i.e., International Monetary Fund, International Bank for Reconstruction and Development, European Bank for Reconstruction and Development, International Development Association, International Finance Corporation, Multilateral Investment Guarantee Agency, African Development Bank, African Development Fund, Asian Development Bank, Inter-American Development Bank, Bank for Economic Cooperation and Development in the Middle East and North Africa, Inter-American Investment Corporation, Council of Europe Development Bank, Nordic Investment Bank, Caribbean Development Bank, European Investment Bank and European Investment Fund (the International Bank for Reconstruction and Development, International Finance Corporation, and Multilateral Investment Guarantee Agency are parts of the World Bank Group). See id. at 51825.
 Under the new definition IFIs will include the International Monetary Fund, the International Bank for Reconstruction and Development, the Asian Development Bank, the African Development Bank and the United Nations, along with their agencies and pension plans, and any other similar international organizations and their agencies and pension plans.