The Commodity Futures Trading Commission (CFTC) has adopted amendments to CFTC Rule 4.7, including adjustments to the portfolio requirement financial thresholds in the “qualified eligible person” definition and the introduction of an alternative monthly account statement schedule for certain commodity pools. Notably, the CFTC chose not to adopt other previously proposed amendments that would have significantly expanded the regulatory burden on CPOs and CTAs relying on CFTC Rule 4.7.
I. Background
Fund managers operating private funds trading in commodity interests (including, for example, swaps,[1] futures, and options)) and fund of funds investing in such funds need to assess their status as commodity pool operators (CPO) and commodity trading advisors (CTA) to determine their CPO/CTA registration obligations under rules promulgated by the CFTC. While many private funds rely on the de minimis trading exemption under CFTC Rule 4.13(a)(3) and fund-of-fund managers continue to rely on related guidance, certain funds that exceed these limitations rely on CFTC Rule 4.7, commonly referred to as a “registration light” regime.
On September 12, 2024, the CFTC approved final rules amending CFTC Rule 4.7 (Final Rules).[2] CFC Rule 4.7 provides exemptions for a registered CPO and a registered CTA with respect to commodity pools (4.7 Pools) and accounts (4.7 Accounts; collectively with 4.7 Pools, 4.7 Pools and Accounts) whose pool participants and account holders, respectively, are solely “qualified eligible persons” (QEP) (that is, persons whom the CFTC considers to be sophisticated investors). These exemptions provide such CPOs and CTAs with relief from certain disclosure, reporting and recordkeeping requirements that would otherwise apply to them. The purpose of CFTC Rule 4.7 is to streamline compliance for CPOs and CTAs dealing with sophisticated investors who do not require the same level of disclosure as less sophisticated retail investors, thereby reducing the regulatory burden placed on them while maintaining adequate protections.
II. Amendments to CFTC Rule 4.7
A. Increasing the QEP Definition’s Portfolio Requirement
The QEP definition is separated into two distinct groups of persons, those who must satisfy the portfolio requirement (see the persons listed under CFTC Rule 4.7(a)(3)) and those who do not (see the persons listed under CFTC Rule 4.7(a)(2)). A person subject to the portfolio requirement can satisfy its requirements by complying with one of the below tests (or some combination of the two):
- Securities Portfolio Test: own securities (including interests in a commodity pool) of issuers not affiliated with such person and other investments with an aggregate market value of at least USD 2 million; or
- Initial Margin Premium Test: having on deposit with a futures commission merchant, for such person’s own account of at least USD 200,000 in exchange-specified initial margin and option premiums, together with required minimum security deposits for retail forex transactions, for commodity interests (including, for example, swaps, futures, and options).
Under the Final Rules, the CFTC has increased the financial thresholds within the portfolio requirement as follows:
- Securities Portfolio Test: The requirement for owning securities and other investments has been raised from USD 2 million to USD 4 million.
- Initial Margin Premium Test: The requirement for having funds on deposit with a futures commission merchant has increased from USD 200,000 to USD 400,000.
According to the CFTC, its aim, by increasing these financial thresholds, is to account for inflation and to align the QEP definition with the original intent of CFTC Rule 4.7, which is to ensure participants and holders in 4.7 Pools and Accounts possess the necessary financial acumen and resources by differentiating between retail and sophisticated investors.
Considerations for 4.7 Pools and Accounts
As is currently the case, the amended QEP definition (incorporating the above increases in the financial thresholds for the portfolio requirement) are to be applied at the time of sale of an interest in, or the opening of, a 4.7 Pool or Account. The applicable CPO or CTA must have the reasonable belief, at such applicable time, that the person in question satisfies the portfolio requirement.
The effect of these increased financial thresholds on private funds:
- Section 3(c)(7) funds[3] relying on CFTC Rule 4.7: These funds should not be affected by the increased financial thresholds because they only admit “qualified purchasers,” which are already included in the QEP definition (and are not subject to the portfolio requirement).
- Section 3(c)(1) funds[4] relying on CFTC Rule 4.7: These funds will need to include the increased financial thresholds in their offering and subscription documents by the compliance date noted below.
With respect to 4.7 Pools and Accounts that admitted investors under the previous financial thresholds for the portfolio requirement, if any such investor would not meet the updated financial thresholds, there is no requirement to redeem such investor’s participations or terminate the advisory relationship with that investor as a result of the increased financial thresholds. However, the CPOs and CTAs of such funds and accounts, respectively would not be permitted to sell any additional fund interests or open any new accounts for any investor that does not meet these updated financial thresholds.
Considerations for CFTC Rule 4.13(a)(3) Commodity Pools
CFTC Rule 4.13(a)(3) provides an exemption from registration as a CPO for an operator of a commodity pool that satisfies certain trading limits applicable to that pool’s commodity interest positions. There are several conditions that need to be satisfied under this rule —relevantly, one of these is that all the investors in the applicable commodity pool satisfy the investor suitability requirements at the time of investment (and at the time a commodity pool converts to a CFTC Rule 4.13(a)(3) commodity pool). This requirement is ordinarily satisfied by ensuring all the investors are accredited investors or QEPs (among other stated suitability categories).[5] While the QEP definition has been amended to increase the portfolio requirement financial thresholds (see above), many operators of CFTC Rule 4.13(a)(3) commodity pools are unlikely to be substantively affected given their investor base would likely be accredited investors (which removes the need to satisfy the QEP definition).
To the extent CPOs of CFTC Rule 4.13(a)(3) commodity pools do rely on the QEP definition to satisfy the investor suitability requirement, they should similarly look to update their offering documents to reflect the new QEP definition’s portfolio requirement financial thresholds.
B. Monthly Account Statements for Funds of Funds
The Final Rules introduced a provision allowing CPOs of 4.7 Pools that are fund of funds (i.e., commodity pools that invest in unrelated funds, pools, or other collective investment vehicles) to distribute account statements on a monthly basis, within 45 days of month-end. This change codifies existing practices established through CFTC exemptive letters and is intended to accommodate the operational realities of fund of funds, which may not receive timely information from underlying investments.
III. Compliance Dates
The compliance date for the increased financial thresholds for the QEP definition’s portfolio requirements is March 26, 2025.
The monthly account statement amendments will be available to CPOs on and following November 25, 2024, with compliance required when a CPO elects to utilize the distribution schedule for qualifying 4.7 Pools.
IV. Proposed Amendments not Included in the Final Rule
In the CFTC’s proposing rules release in October 2023,[6] the CFTC included amendments that would have increased the level of disclosure required by CPOs of 4.7 Pools by requiring descriptions of (i) principal risk factors, (ii) investment program, (iii) use of proceeds, (iv) custodian, (v) fees and expenses, (vi) conflicts of interest, and (vii) targeted past performance information. There were also corresponding updates to the recordkeeping requirements, as well as the application of the use and amendment provisions to this disclosed information.
The proposing rule also included similar amendments applicable to CTAs of 4.7 Accounts by requiring these CTAs to deliver additional disclosures describing (i) the trading program, (ii) certain persons to be identified, (iii) principal risk factors for the CTA’s trading program, (iv) fees, (v) conflicts of interest, and (vi) targeted past performance information.
These additional disclosures applicable to 4.7 Pools and Accounts would have been implemented by rescinding or narrowing many of the existing exemptions under CFTC Rule 4.7.
In the guidance associated with the Final Rules, the CFTC noted significant push-back from market participants on these proposed amendments. As a result, the CFTC decided not to include these proposed amendments in the Final Rules noting that the CFTC would take additional time to consider the concerns and alternatives expressed by market participants.
Note that CPOs and CTAs remain subject to the existing requirement that any information or disclosures they elect to provide a QEP must include all disclosures necessary to make the information contained therein, in the context in which it is furnished, not misleading.
[1] In 2012, the CFTC included “swaps” within the meanings of “commodity pool” and “commodity interests.” The CFTC and the Securities and Exchange Commission published final rules defining the term “swap” on August 13, 2012 .
[2] Commodity Futures Trading Commission, Final Rule, Commodity Pool Operators, Commodity Trading Advisors, and Commodity Pools Operated under Regulation 4.7: Updating the ‘Qualified Eligible Person’ Definition; Adding Minimum Disclosure Requirements for Pools and Trading Programs; Permitting Monthly Account Statements for Funds of Funds; Technical Amendments (89 FR 78793).
[3] A Section 3(c)(7) fund is a pooled investment vehicle that restricts investors to “qualified purchasers” and complies with the additional requirements set forth in Section 3(c)(7) of the Investment Company Act.
[4] A Section 3(c)(1) fund is a pooled investment vehicle that has no more than 100 beneficial owners (or 250 beneficial owners for a venture capital fund) and complies with the additional requirements set forth in Section 3(c)(1) of the Investment Company Act.
[5] CFTC Rule 4.13(a)(3)(iii) sets out the investor suitability requirements.
[6] Commodity Futures Trading Commission, Proposed Rule, Commodity Pool Operators, Commodity Trading Advisors, and Commodity Pools: Updating the ‘Qualified Eligible Person’ Definition; Adding Minimum Disclosure Requirements for Pools and Trading Programs; Permitting Monthly Account Statements for Funds of Funds; Technical Amendments (88 FR 70852).
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