Exchange-traded funds (ETFs) investing in commodities and their advisers, that are registered or required to be registered with the Commodity Futures Trading Commission (CFTC) as commodity pool operators (CPOs) or commodity trading advisors (CTAs), are accustomed to navigating a broad range of complex laws and regulations. Due, in large part, to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) and increased scrutiny by regulators of the financial and commodities markets, 2012 promises to bring a host of new regulatory requirements and issues for CPOs and CTAs. Below are five areas that members of the commodity ETF industry will want to watch in 2012.

MF Global, Inc.’s recent collapse has raised questions in the commodity ETF industry about the safety of futures customers’ collateral. Under existing commodities laws and regulations, customer collateral held by a futures commission merchant (FCM) or derivatives clearing organization (DCO), as margin or otherwise, must be segregated from the proprietary funds of the FCM or DCO. Segregation of customer collateral is the primary protection afforded to futures customers and is considered sacrosanct by futures market participants, including commodity ETFs and generally.

CFTC regulations and other systems created to provide protections to customer collateral have not met their intended goal. To date, much of the approximately $1.2 billion shortfall of MF Global customer funds remains unaccounted for by regulators. Investigations into the whereabouts of the missing funds are ongoing, including whether the funds were misappropriated in the days leading up to MF Global’s demise. In response to the unfolding developments from MF Global, the CFTC is expected to review and may revise its regulations pertaining to how customer collateral for futures transactions can be held. Last month, the CFTC adopted a legal segregation with operational commingling model (the LSOC Model) for the segregation of cleared swaps customers’ collateral. In discussing the LSOC Model, CFTC staff confirmed that they are currently evaluating what enhanced protections may be afforded to futures customers’ collateral and that the LSOC Model will serve as a baseline. Commodity ETFs, CPOs and CTAs trading in the futures market should monitor changes to CFTC regulations intended to better protect customer collateral and be prepared to adapt their current business practices accordingly. Commodity ETFs should evaluate whether their own FCMs, and the DCOs that such FCMs are members of, are meeting regulatory requirements. In addition, commodity ETFs and their CPOs and CTAs should closely monitor such entities’ risk profiles and whether they are able to meet their customer obligations.

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