The National Futures Association (NFA) has proposed a new rule that would require registered commodity pool operators (CPOs) that are members of the NFA (CPO Members) to report to the NFA by 5:00 pm Central Time the next business day after the occurrence of a reportable event relating to the inability of a fund operated by the CPO Member to meet a margin call or satisfy redemption requests, or relating to a commodity pool that has halted redemptions or is declared in default by a swap counterparty.
To identify CPO Members that operate pools that have been adversely affected by a market or other event, the NFA has proposed Compliance Rule 2-50 to require a CPO Member to report to the NFA if the CPO Member becomes subject to one of the “reportable events” enumerated in the rule:
When reporting is required, a CPO Member must notify the NFA by 5:00 pm CT the following business day after a reportable event has occurred, in the form and manner prescribed by the NFA. The rule does not elaborate on the form and manner of reporting, but other types of notifications to the NFA are filed online through an NFA portal, and we expect that the NFA will provide a similar type of portal for this new CPO reporting.
Although the new rule enumerates specific circumstances when CPO reporting requirements arise, the NFA provides guidance to clarify that certain scenarios will not give rise to a reporting requirement. The guidance demonstrates the NFA’s view that certain events—which may technically be reportable events—are not the type of events that the NFA is trying to monitor through this new rulemaking and, therefore, reporting would not be required for such events.
A CPO Member would be required to report to the NFA if one of its commodity pools is unable to meet a margin call, but only once the CPO Member has determined that the pool is not able to meet the margin call. Thus, in situations where a pool can meet a margin call within the requisite timeframe if it alters its portfolio or accesses other means to satisfy the margin call, no reporting to the NFA would be required.
In addition, reporting would not be required when a CPO Member disputes the amount or appropriateness of the margin call if a pool has sufficient assets to satisfy the greatest of the disputed amount. If the pool cannot satisfy the greatest of the disputed amount when there is a dispute, however, the pool’s CPO Member would be required to report to the NFA pursuant to Compliance Rule 2-50.
Although the proposed rule does not elaborate on whether the failure to meet a margin call applies to futures, swaps, and securities, the spirit of the rule would suggest that the NFA is interested in the inability to meet any margin call, regardless of product type.
Inability to Satisfy Redemption Requests
The new rule would require a CPO Member to report to the NFA if it operates a commodity pool that is unable to satisfy redemption requests in accordance with its subscription agreements. The NFA guidance explains that a CPO Member would need to notify the NFA about an inability to satisfy a redemption request when it has determined that a pool will not be able to meet a redemption request within the terms of the pool’s subscription agreement, even if the applicable grace period has not yet expired.
However, the NFA clarified that a CPO Member would not be required to report to the NFA (1) if a pool has securities that will mature within a redemption grace period that can be used to satisfy the redemption; and (2) when the CPO Member may offer a participant an in-kind distribution or side pocket in lieu of a cash distribution.
A CPO Member would be subject to reporting requirements when a pool unexpectedly halts redemptions (whether temporarily or permanently) as a result of a market or other event that affects the pool’s ability to satisfy redemptions. However, reporting would not be required when a CPO Member liquidates a pool in the ordinary course of business, i.e., not as a result of a market or other unexpected event.
A CPO Member also need not report to the NFA when a pool halts redemptions pursuant to a predetermined gate or lockup dependent on a base level of funding and as set forth in the pool’s subscription agreement.
When a CPO Member does not reasonably believe that a pool can cure a default to a swap counterparty on a margin call within the prescribed cure period, the CPO Member would be required to report to the NFA about such event. Reporting would be required in this case even if the pool and swap counterparty are in discussions to liquidate positions or if the pool disputes the default notice.
Relevant treasury or accounting personnel who would be aware of the types of margin call or redemption issues that could trigger reporting should be notified about the new requirements to ensure that the CPO Member timely reports to the NFA when necessary. In addition, CPO Members will need to update their policies and procedures to reflect the new reporting requirements.
The NFA submitted to the Commodity Futures Trading Commission the proposed rule on March 5, 2021, under the 10-day self-certification process. Notwithstanding the self-certification process, the NFA generally announces an effective date for new rules, and CPO Members should monitor when the NFA makes Compliance Rule 2-50 effective.
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