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Regulators: Matthew Kerfoot from law firm Dechert reviews possible regulatory changes related to commodity funds.

Friday, January 07, 2011


Matthew Kerfoot

Commodity Funds and Pools

The following article was written by Chidem Kurdas based on a talk with Matthew Kerfoot from law firm Dechert LLP. Mr. Kerfoot advises clients on the regulation of derivatives, commodities, and securities. Before joining Dechert he was a senior vice president on HSBC's structured fund products desk in New York.

He discusses areas of regulatory change in the United States of relevance to fund managers and sponsors.


An exciting area is the development of exchange-traded funds that are not subject to the 1940 Investment Company Act. These invest in commodities, not in securities, and are not mutual funds but trusts traded on exchanges.

If what a fund trades is clearly not a security and hence not subject to regulation by the Securities and Exchange Commission, then there is a good chance that the fund will not need to register as a 1940 Act mutual fund. This will matter for fund sponsors and managers who want to expeditiously bring a commodity product to the market. Registering as a 1940 Act fund significantly slows down the process.

There are a number of such 1933 Act registered funds up and running. Currently they are a small part of the market. But I think the Dodd-Frank Act opens a pathway for more funds because there should be less uncertainty as to what constitutes a security.

Dodd-Frank provides the Commodity Futures Trading Commission with a huge amount of regulatory jurisdiction. Every swap will now be regulated by the CFTC. This includes interest rate and foreign exchange swaps. The exception is swaps for single securities and small baskets of securities.

You can make the argument that a fund investing in swaps - regulated by the CFTC and not the SEC - can operate outside the confines of the 1940 Act. That would allow you to launch a product in a relatively short time frame and have it listed, compared with the fairly lengthy wait you would have with the SEC for a 1940 Act fund. The wait there is well over a year.

Mutual Funds

Another possible fund-related rule change was proposed by the National Futures Association. This would require mutual funds that use more than a minimal amount of futures to register as commodity pool operators. The reasoning is that the SEC is a securities regulator, not a futures and commodities regulator, and hence does not have the experience and appropriate background to oversee futures-trading entities.

The NFA requests that certain restrictions be restored to CFTC Regulation 4.5, which was amended in 2003 to allow wider exemption from CPO registration. In particular, the NFA petition asks for a prohibition on marketing to the public of products that offer indirect exposure to commodities through the trading of commodity futures or options.

There are nearly four dozen mutual funds offering commodity exposure, with more than $30 billion in assets. Retail investors increasingly seek commodity exposure. Commodity mutual funds are subject to extensive regulation by the SEC and no unique problems have shown up. The changes petitioned by the NFA could adversely affect commodity mutual funds and their investors without bringing sufficient benefits to justify the costs.

This issue is dormant but the NFA proposal remains under consideration. Some people believe that it may ultimately be adopted by the CFTC. If that happens, mutual funds that trade futures could end up as dual regulated by both the SEC and the CFTC.

As a separate matter, fund managers registered as commodity pool operators might benefit from less onerous reporting and other requirements-if they get certain exemptions given to exchange-traded funds. A number of commodity ETFs have been registered with the CFTC for years as CPOs. These include actively-managed commodity funds as well as index-based funds. These ETFs received relief from certain reporting, disclosure and recordkeeping requirements.

That relief was on a case-by-case basis. This September the CFTC proposed changes that would codify the exemptions and in addition exempt the trustees and directors of actively-managed commodity ETFs from CPO registration. Possibly mutual funds would get similar exemptions.

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2010 Selected Proposals Related to Commodity Funds and Pools

Request by the Options Clearing Corporation for approval to clear options and security futures on certain exchange traded funds based on palladium and platinum

Whether the CFTC should categorically exempt the trading and clearing of certain options and futures on gold, silver palladium and platinum from the provisions of the Commodity Exchange Act

Proposal to exempt the trading and clearing of options on the CBOE Gold ETF Volatility Index from the Commodity Exchange Act

Relief from compliance with certain disclosure, reporting and recordkeeping requirements for registered operators of commodity pools listed for trading on a national securities exchange and registration exemption for certain independent directors or trustees of these commodity pools

Proposal to exempt the trading and clearing of certain contracts related to ETFS Physical Swiss Gold Shares and ETFS Physical Silver Shares from the Commodity Exchange Act
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