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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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