Exemption From Registration for Certain Foreign Persons Acting as Commodity Pool Operators of Offshore Commodity Pools
| Citation | 85 FR 35820 |
| Record Number | 2020-12034 |
| Published date | 12 June 2020 |
| Court | Commodity Futures Trading Commission |
Federal Register, Volume 85 Issue 114 (Friday, June 12, 2020)
[Federal Register Volume 85, Number 114 (Friday, June 12, 2020)]
[Proposed Rules]
[Pages 35820-35835]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-12034]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 3
RIN 3038-AE46
Exemption From Registration for Certain Foreign Persons Acting as
Commodity Pool Operators of Offshore Commodity Pools
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking; reopening of comment period.
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SUMMARY: The Commodity Futures Trading Commission (Commission) is
proposing to amend the conditions in Commission regulation 3.10(c)
under which a person located outside of the United States engaged in
the activity of a commodity pool operator (CPO; each person located
outside of the United States a non-U.S. CPO) in connection with
commodity interest transactions on behalf of persons located outside
the United States (collectively, an offshore commodity pool or offshore
pool) would qualify for an exemption from CPO registration and
regulation with respect to that offshore pool. Specifically, through
amendments to Commission regulation 3.10(c), the Commission is
proposing that non-U.S. CPOs may claim an exemption from registration
with respect to its qualifying offshore commodity pools, while
maintaining another exemption from registration, relying on an
exclusion, or registering as a CPO with respect to the operation of
other commodity pools. The Commission is also proposing to add a safe
harbor by which a non-U.S. CPO of an offshore commodity pool may rely
upon the proposed exemption in Commission regulation 3.10(c) if they
satisfy enumerated factors related to the operation of the offshore
commodity pool. Additionally, the Commission is proposing to permit
certain U.S. control affiliates of a non-U.S. CPO to contribute capital
to such CPO's offshore pools as part of the initial capitalization
without rendering the non-U.S. CPO ineligible for the exemption from
registration under Commission regulation 3.10.
DATES: Comments must be received on or before August 11, 2020.
ADDRESSES: You may submit comments, identified by RIN 3038-AE46, by any
of the following methods:
CFTC Comments Portal: http://comments.cftc.gov. Select the ``Submit
Comments'' link for this rulemaking and follow the instructions on the
Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the Commission,
Commodity Futures Trading Commission, Three Lafayette Center, 1155 21st
Street NW, Washington, DC 20581.
Hand Delivery/Courier: Same as Mail above.
Please submit your comments using only one of these methods. To
avoid possible delays with mail or in-person deliveries, submissions
through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should submit only information that you
wish to make publicly available. If you wish the Commission to consider
information that may be exempt from disclosure under the Freedom of
Information Act (FOIA), a petition for confidential treatment of the
exempt information may be submitted according to the procedures
established in Sec. 145.9 of the Commission's regulations.\1\
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\1\ 17 CFR 145.9. Commission regulations referred to herein are
found at 17 CFR Chapter I (2019).
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The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from https://comments.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
FOIA.
FOR FURTHER INFORMATION CONTACT: Joshua B. Sterling, Director, (202)
418-6056, [email protected], Amanda Lesher Olear, Deputy Director,
(202) 418-5283, [email protected], or regarding Section III of this
Notice of Proposed Rulemaking, Frank Fisanich, Chief Counsel, (202)
418-5949, [email protected], Division of Swap Dealer and Intermediary
Oversight, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
Section 1a(11) of the Commodity Exchange Act (CEA or Act) \2\
defines the term ``commodity pool operator'' as any
[[Page 35821]]
person \3\ engaged in a business that is of the nature of a commodity
pool, investment trust, syndicate, or similar form of enterprise, and
who, with respect to that commodity pool, solicits, accepts, or
receives from others, funds, securities, or property, either directly
or through capital contributions, the sale of stock or other forms of
securities, or otherwise, for the purpose of trading in commodity
interests.\4\ CEA section 1a(10) defines a ``commodity pool'' as any
investment trust, syndicate, or similar form of enterprise operated for
the purpose of trading in commodity interests.\5\ CEA section 4m(1)
generally requires each person who satisfies the CPO definition to
register as such with the Commission.\6\ With respect to CPOs, the CEA
also authorizes the Commission, acting by rule or regulation, to
include within or exclude from the term ``commodity pool operator'' any
person engaged in the business of operating a commodity pool if the
Commission determines that the rule or regulation will effectuate the
purposes of the CEA.\7\
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\2\ See 7 U.S.C. 1, et seq. (2019). The CEA and the Commission's
regulations are accessible through the Commission's website, https://www.cftc.gov.
\3\ See 17 CFR 1.3 (defining ``person'' to include individuals,
associations, partnerships, corporations, and trusts).
\4\ 7 U.S.C. 1a(11). See also 17 CFR 1.3 (defining ``commodity
interest'' to include any contract for the purchase or sale of a
commodity for future delivery, and any swap as defined in the CEA);
Adaptation of Regulations to Incorporate Swaps, 77 FR 66288, 66295
(Nov. 2, 2012) (discussing the modification of the term ``commodity
interest'' to include swaps).
\5\ 7 U.S.C. 1a(10).
\6\ 7 U.S.C. 6m(1).
\7\ 7 U.S.C. 1a(11)(B).
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Additionally, CEA section 4(c), in relevant part with respect to
this proposal, provides that the Commission, to promote responsible
economic or financial innovation and fair competition, by rule,
regulation, or order, after notice and opportunity for hearing, may
exempt, among other things, any person or class of persons offering,
entering into, rendering advice, or rendering other services with
respect to commodity interests from any provision of the Act.\8\
Section 4(c) authorizes the Commission to grant exemptive relief if the
Commission determines, inter alia, that the exemption would be
consistent with the ``public interest.'' \9\
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\8\ 7 U.S.C. 6(c)(1).
\9\ See Conference Report, H.R. Report 102-978 at 8 (Oct. 2,
1992) (``The goal of providing the Commission with broad exemptive
powers . . . is to give the Commission a means of providing
certainty and stability to existing and emerging markets so that
financial innovation and market development can proceed in an
effective and competitive manner.'').
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To provide an exemption pursuant to section 4(c) of the Act with
respect to registration as a CPO, the Commission must determine that
the agreements, contracts, or transactions undertaken by the exempt CPO
should not require registration and that the exemption from
registration would be consistent with the public interest and the
Act.\10\ The Commission must further determine that the agreement,
contract, or transaction will be entered into solely between
appropriate persons and that it will not have a material adverse effect
on the ability of the Commission or any contract market to discharge
its regulatory or self-regulatory duties under the Act.\11\ The term
``appropriate person'' as used in section 4(c) includes a commodity
pool formed or operated by a person subject to regulation under the
Act.\12\ The Commission has previously interpreted the clause ``subject
to regulation under the Act'' as including persons who are exempt from
registration or excluded from the definition of a registration
category.\13\
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\10\ 7 U.S.C. 6(c)(2)(A).
\11\ Id. at 6(c)(2)(B).
\12\ Id. at 6(c)(3)(E).
\13\ See Further Definition of ``Swap Dealer'', 77 FR 30596,
30655 (May 23, 2012) (finding, in the context of the eligible
contract participant definition, that ``construing the phrase
`formed and operated by a person subject to regulation under the
[CEA]' to refer to a person excluded from the CPO definition,
registered as a CPO or properly exempt from CPO registration
appropriately reflects Congressional intent'').
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Part 3 of the Commission's regulations governs the registration of
intermediaries engaged in, inter alia, the offering and selling of, and
the provision of advice concerning, all commodity interest
transactions. Commission regulation 3.10 establishes the procedure that
intermediaries, including CPOs, must use to register with the
Commission.\14\ Commission regulation 3.10 also establishes certain
exemptions from registration.\15\ In particular, Commission regulation
3.10(c)(3) (referred to herein as the 3.10 Exemption) provides that,
inter alia, a person engaged in the activity of a CPO, in connection
with any commodity interest transaction executed bilaterally or made on
or subject to the rules of any designated contract market or swap
execution facility, is not required to register as a CPO, provided
that:
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\14\ See, e.g., 17 CFR 3.10(a)(1)(i) (requiring the filing of a
Form 7-R with the National Futures Association (NFA)).
\15\ See 17 CFR 3.10(c) (exemption from registration for certain
persons).
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1. The person is located outside the United States, its
territories, and possessions (the United States or U.S.) (a non-U.S.
CPO);
2. The person acts only on behalf of persons located outside the
United States (an offshore commodity pool); and
3. The commodity interest transaction is submitted for clearing
through a registered futures commission merchant.\16\
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\16\ 17 CFR 3.10(c)(3)(i). But see CFTC Staff Letters No. 16-08
and 15-37. Pursuant to these letters, Commission staff in the
Division of Swap Dealer and Intermediary Oversight (DSIO) recognized
that not all swaps are required to be cleared, and thus provided
relief from registration for certain intermediaries acting on behalf
of persons located outside the United States or on behalf of certain
International Financial Institutions in connection with swaps not
subject to a Commission clearing requirement. In 2016, the
Commission published a proposed rule that would codify the position
articulated in these DSIO staff letters. See Exemption from
Registration for Certain Foreign Persons, 81 FR 51824 (Aug. 5,
2016). The Commission is reopening the comment period on such
proposed rule pursuant to this Proposal. See Section III, infra.
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A person acting in accordance with the 3.10 Exemption remains
subject to the antifraud provisions of CEA section 4o,\17\ but is
otherwise not required to comply with those provisions of the CEA or
Commission regulations applicable to any person registered in such
intermediary capacity or persons required to be so registered.\18\ The
3.10 Exemption provides that it is available to non-U.S. CPOs whose
activities, in connection with any commodity interest transaction
executed bilaterally or made on or subject to the rules of any
designated contract market or swap execution facility, are confined to
acting on behalf of offshore commodity pools.\19\ This exemption was
first adopted in 2007 and was based on a long-standing no-action
position articulated by the Commission's Office of General Counsel in
1976.\20\
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\17\ 7 U.S.C. 6o.
\18\ 17 CFR 3.10(c)(3)(ii). As market participants, however,
such persons remain subject to all other applicable provisions of
the CEA and the Commission's regulations promulgated thereunder.
\19\ 17 CFR 3.10(c)(3)(i).
\20\ Exemption from Registration for Certain Foreign Persons, 72
FR 63976, 63977 (Nov. 14, 2007). See CFTC Staff Interpretative
Letter 76-21.
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In adopting the final rule amending Commission regulation 3.10, the
Commission agreed with commenters who cited its longstanding policy of
focusing ``customer protection activities upon domestic firms and upon
firms soliciting or accepting orders from domestic users of the futures
markets.'' \21\ The Commission further stated that the protection of
non-U.S. customers of non-U.S. firms may be best deferred to foreign
regulators.\22\ The
[[Page 35822]]
Commission noted its understanding that, pursuant to the terms of the
3.10 Exemption, ``[a]ny person seeking to act in accordance with any of
the foregoing exemptions from registration should note that the
prohibition on contact with U.S. customers applies to solicitation as
well as acceptance of orders.'' \23\ Moreover, the Commission stated
that ``[if] a person located outside the U.S. were to solicit
prospective customers located in the U.S. as well as outside of the
U.S., these exemptions would not be available, even if the only
customers resulting from the efforts were located outside the U.S.''
\24\
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\21\ Exemption from Registration for Certain Foreign Persons, 72
FR at 63977, quoting Introducing Brokers and Associated Persons of
Introducing Brokers, Commodity Trading Advisors and Commodity Pool
Operators; Registration and Other Regulatory Requirements, 48 FR
35248, 35261 (Aug. 3, 1983).
\22\ Id. The Commission also cited this policy position in the
initial proposal for what ultimately became Commission regulation
3.10(c)(3)(i). See Exemption from Registration for Certain Foreign
Persons, 72 FR 15637, 15638 (Apr. 2, 2007).
\23\ Exemption from Registration for Certain Foreign Persons, 72
FR at 63977-78.
\24\ Id. at 63978.
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In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection
Act (Dodd-Frank Act) \25\ amended the definition of ``commodity pool
operator'' and ``commodity pool'' to include those persons operating
collective investment vehicles that engage in swaps,\26\ which resulted
in an expansion of the universe of persons captured within the
statutory definitions of both CPOs and commodity pools. When combined
with the rescission of Commission regulation 4.13(a)(4) in 2012,\27\ an
increasing number of non-U.S. CPOs were required to either register
with the Commission or claim an available exemption or exclusion with
respect to the operation of their commodity pools, both offshore pools
and those offered to U.S. participants.
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\25\ Public Law 111-203, H.R. 4173 (2010).
\26\ See Section 721 of the Dodd-Frank Act.
\27\ See Commodity Pool Operators and Commodity Trading
Advisors; Compliance Obligations, 77 FR 11252, 11264 (Feb. 24,
2012). Former Commission regulation 4.13(a)(4) provided an exemption
from registration as a CPO for operators of commodity pools offered
and sold to sophisticated participants. See 17 CFR 4.13(a)(4)
(2010).
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In 2018, the Commission proposed adding a new exemption in
Commission regulation 4.13 to codify the relief provided in CFTC Staff
Advisory 18-96 (Advisory 18-96).\28\ As part of that proposal, the
Commission noted that the proposed exemption based on Advisory 18-96
could be claimed on a pool-by-pool basis, and stated that ``[t]his
characteristic would effectively differentiate the [proposed exemption]
from the relief currently provided'' under the 3.10 Exemption.\29\ The
Commission received several comments regarding that aspect of the
proposal. One commenter noted that the 3.10 Exemption ``is widely
relied on around the world by non-U.S. managers of offshore funds that
are not offered to U.S. investors but that may trade in the U.S.
commodity interest markets.'' \30\ This commenter further noted that
``CPO registration for these offshore entities with global operations
is not a viable option[,]'' due to the logistical and regulatory issues
involved.\31\ Another commenter stated that, ``it is critical to bear
in mind that the Commission . . . to our knowledge has never addressed,
the separate and distinct question of whether an offshore CPO may rely
on Rule 3.10(c)(3)(i) with respect to some of its offshore pools in
combination with relying on other exemptions with respect to its other
pools.'' \32\ Several other commenters expressed similar views and
requested that the Commission affirm the ability to claim the 3.10
Exemption on a pool-by-pool basis and to rely upon that exemption in
addition to other exemptions, exclusions, or registration.\33\
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\28\ Registration and Compliance Requirements for Commodity Pool
Operators and Commodity Trading Advisors, 83 FR 52902 (Oct. 18,
2018); CFTC Staff Advisory 18-96 (Apr. 11, 1996).
\29\ Registration and Compliance Requirements for Commodity Pool
Operators and Commodity Trading Advisors, 83 FR at 52914.
\30\ See Comment letter from the Asset Management Group of the
Securities Industry and Financial Markets Association (SIFMA AMG) at
9 (Dec. 17, 2018), available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61922&SearchText=.
\31\ Id. at 12.
\32\ See Comment letter from Fried, Frank, Harris, Shriver, &
Jacobson, LLP (Fried Frank) at 6 (Dec. 17, 2018), available at
https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61920&SearchText=.
\33\ See, e.g., Comment letter from Willkie, Farr, and
Gallagher, LLP (Willkie) at 6 (Dec. 11, 2018), available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61927&SearchText=; Comment letter from
Alternative Investment Management Association (AIMA) at 6 (Dec. 17,
2018), available at https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61907&SearchText=.
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In 2019, the Commission withdrew its proposal to codify the relief
provided in Advisory 18-96, and, in light of the comments received in
response to the discussion of the 3.10 Exemption, instead undertook an
inquiry as to whether the 3.10 Exemption should be amended to respond
to the current CPO space and the issues articulated by commenters.\34\
Based on the foregoing, and in light of the increasingly global nature
of the commodity pool space, the Commission preliminarily believes that
the statutory and regulatory developments since 2007 have resulted in a
growing mismatch between the Commission's stated policy purposes
underlying the 3.10 Exemption, which are to focus the Commission's
resources on the protection of U.S. persons, and the 3.10 Exemption as
adopted in 2007. Therefore, the Commission has preliminarily determined
that it is appropriate to amend the 3.10 Exemption to better align the
terms of the exemption with the Commission's continued policy goals.
The result is this proposal.
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\34\ Registration and Compliance Requirements for Commodity Pool
Operators (CPOs) and Commodity Trading Advisors: Family Offices and
Exempt CPOs, 84 FR 67355, 67357 (Dec. 10, 2019).
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II. The Proposal
The Commission is proposing, pursuant to its authority under CEA
section 4(c), several amendments to the current 3.10 Exemption (the
Proposal). Specifically, the Commission is proposing amendments to the
3.10 Exemption such that non-U.S. CPOs may rely on that exemption on a
pool-by-pool basis to better reflect the current state of operations of
CPOs. The Commission is also proposing a conditional safe harbor to
enable non-U.S. CPOs who, by virtue of the structure of their offshore
pool, cannot with certainty represent that there are no U.S.
participants in their operated pool, to rely on the 3.10 Exemption. The
Commission is further proposing that the revised 3.10 Exemption be
available to be claimed along with other exemptions or exclusions
available to CPOs generally and to provide an exception from the U.S.
participant prohibition in the 3.10 Exemption for initial capital
contributions received from a U.S. controlling affiliate of an offshore
pool's non-U.S. CPO.
a. Pool-by-Pool Exemption
The Commission understands that non-U.S. CPOs may operate both
offshore commodity pools and commodity pools on behalf of persons
located inside the United States (U.S. commodity pools or U.S. pools).
As stated previously, however, the 3.10 Exemption prohibits persons
from relying on that relief with respect to certain pools, but not
others. Under a categorical prohibition on contact with U.S. persons by
non-U.S. CPOs seeking to rely on the 3.10 Exemption, a non-U.S. CPO
that operates both offshore pools and pools offered to U.S. persons
would not be eligible for registration relief under Commission
regulation 3.10(c). As a result, a non-U.S. CPO that operates a
combination of offshore and onshore commodity pools would be required
to either list its offshore pools with the Commission and comply with
part 4 of the Commission's regulations with respect to the operation of
those
[[Page 35823]]
pools as if those pools were no different from U.S. commodity pools,
find another available exemption from registration, or claim a
regulatory exclusion with respect to those offshore pools.
The Commission continues to believe that it is advisable to focus
its customer protection activities on U.S. persons and on the persons
and firms that solicit derivatives transactions from those U.S. person
customers.\35\ The Commission's regulatory regime was designed with a
view to ensuring U.S. persons solicited for and participating in
commodity pools receive the full benefit of the customer protections
provided under the Act. The current terms of the 3.10 Exemption may
result in the Commission overseeing the operation of commodity pools
that are themselves not domestic either in terms of their location or
participants. The Commission's mandate regarding protection of
customers in the U.S. commodity interest markets with respect to the
operation of commodity pools is primarily focused on protecting U.S.
pool participants, not commodity pools located outside the United
States that have only non-U.S. pool participants. Reducing regulation
of commodity pools that are outside of the Commission's primary
customer protection mandate also allows the Commission to more
effectively apply its resources for this purpose. Therefore, the
Commission is proposing to amend Commission regulation 3.10(c)(3) such
that non-U.S. CPOs may avail themselves of the 3.10 Exemption on a
pool-by-pool basis by specifying that the availability of the 3.10
Exemption would be determined by whether all of the participants in a
particular offshore pool are located outside the United States. The
Commission preliminarily believes that amending the 3.10 Exemption such
that non-U.S. CPOs may claim relief on a pool-by-pool basis
appropriately focuses Commission oversight on those pools that solicit
and/or accept U.S. persons as pool participants.
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\35\ See Exemption from Registration for Certain Foreign
Persons, 72 FR at 63977.
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Moreover, since the adoption of the 3.10 Exemption in 2007,
Congress expanded the Commission's jurisdiction to include, among other
things, transactions in swaps \36\ and rolling spot retail foreign
exchange transactions.\37\ When combined with amendments to, as well as
the rescission of, various regulatory exemptions, this has necessarily
resulted in an increase in the variety of persons captured within the
definition of a CPO.\38\ Additionally, the Commission notes the
increasing globalization of the commodity pool industry. For example,
unlike when Commission regulation 3.10(c)(3)(i) was originally adopted,
when measured by assets under management, today several of the largest
CPOs are located outside the United States, and these larger CPOs
typically operate many different commodity pools including some pools
for U.S. investors and other pools for non-U.S. investors. Upon
consideration of these developments, the Commission has preliminarily
concluded that the 3.10 Exemption should be amended to reflect the
Commission's regulatory interests in such an integrated international
investment management environment. Therefore, the Commission
preliminarily believes that the Proposal, if adopted, would provide
much-needed regulatory flexibility for non-U.S. CPOs operating offshore
commodity pools by taking into account the global nature of their
operations without compromising the Commission's mission of protecting
U.S. pool participants.
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\36\ Wall Street Transparency and Accountability Act of 2010,
Public Law 111-203, 124 Stat. 1376 (2010).
\37\ Food, Conservation, and Energy Act of 2008, Public Law 110-
246, 122 Stat. 1651, 2189-2204 (2008).
\38\ See, e.g., 17 CFR 4.13(a)(3) (swaps added to the enumerated
commodity interests subject to the de minimis threshold following
the Dodd-Frank Act, which effectively narrowed the availability of
the exemption); Commodity Pool Operators and Commodity Trading
Advisors: Amendments to Compliance Obligations, 76 FR 7976 (Feb. 11,
2011) (rescinding Regulation 4.13(a)(4), which provided an exemption
from registration for certain privately offered commodity pools).
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For the reasons stated above, the Commission preliminarily believes
that amending the 3.10 Exemption such that non-U.S. CPOs may claim the
exemption from registration with respect to the operation of their
offshore pools, while claiming an alternative exemption or exclusion,
or registering regarding the operations of their commodity pools that
are offered or sold to U.S. persons, is an appropriate exercise of its
exemptive authority under section 4(c) of the Act. Additionally, the
Commission preliminarily believes that clearly enabling non-U.S. CPOs
to avoid the additional organizational complexity associated with
separately organizing their offshore and domestic facing businesses in
an effort to comply with the provisions of the 3.10 Exemption may
result in more non-U.S. CPOs undertaking to design and offer commodity
pools for persons in the United States. Moreover, the Commission
preliminarily believes that this could result in greater diversity of
pool participation opportunities for U.S. persons and that this
increased competition amongst commodity pools and CPOs could foster
additional innovation regarding commodity pool operations, which is
already one of the more dynamic sectors of the Commission's
responsibility. The Commission further preliminarily believes that this
potential for increased competition and variation in commodity pools
and CPOs would further promote the vibrancy of the U.S. commodity
interest markets.
The Commission has preliminarily determined that the proposed
revisions to the 3.10 Exemption set forth herein will not have a
material adverse effect on the ability of the Commission or any
contract market to discharge their duties under the Act, because non-
U.S. CPOs that would be exempt under the terms of this Proposal would
remain subject to the statutory and regulatory obligations imposed on
all participants in the U.S. commodity interest markets.\39\ The
Commission notes that this preliminary conclusion is consistent with
section 4(d) of the Act, which provides that any exemption granted
pursuant to section 4(c) will not affect the authority of the
Commission to conduct investigations in order to determine compliance
with the requirements or conditions of such exemption or to take
enforcement action for any violation of any provision of the CEA or any
rule, regulation or order thereunder caused by the failure to comply
with or satisfy such conditions or requirements.\40\ Moreover, the
Commission would retain the authority to take enforcement action
against any non-U.S. CPO claiming the 3.10 Exemption based on their
activities within the U.S. commodity interest markets consistent with
its authority regarding market participants generally.
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\39\ See, e.g., 7 U.S.C. 9 (prohibiting the use or employment of
any manipulative or deceptive device in connection with any swap or
contract of sale of any commodity in interstate commerce, or for
future delivery on or subject to the rules of any registered
entity).
\40\ 7 U.S.C. 6(d).
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b. Proposed Safe Harbor With Respect to Inadvertent Participation of
U.S. Participants in Offshore Pools
As discussed above, one of the criteria for relief in current
Commission regulation 3.10(c)(3)(i) is that, in connection with any
commodity interest transaction executed bilaterally or made on or
subject to the rules of any designated contract market or swap
execution facility, the claiming non-U.S. CPO be acting only on behalf
of persons located outside the United States, its
[[Page 35824]]
territories, or possessions.\41\ The Commission understands that non-
U.S. CPOs of offshore pools that are traded in offshore secondary
markets may not have the ability to make such a representation with
certainty as they cannot be assured that only persons located outside
the U.S. would be accepted as participants because the participation
units are not purchased directly from the offshore pool. Moreover, the
Commission also understands that, given the common use of complex
entity structures for tax purposes, a non-U.S. CPO may not have
complete visibility into the ultimate beneficial owners of its offshore
pool's participation units, even in the absence of secondary market
trading.
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\41\ 17 CFR 3.10(c)(3)(i).
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Despite this fairly common lack of visibility into the ultimate
ownership of some offshore pools, the Commission preliminarily believes
that a non-U.S. CPO should be able to rely on the 3.10 Exemption
provided that the non-U.S. CPO undertakes reasonable efforts to
minimize the possibility of U.S. persons being solicited for or sold
participation units in the offshore pool. The Commission preliminarily
believes that non-U.S. CPOs should not be foreclosed from relying upon
the relief available under the 3.10 Exemption solely due to the nature
and structure of the operated offshore pool preventing them from
representing with absolute certainty that no U.S. persons are
participating in that pool, provided that such non-U.S. CPOs take
reasonable actions available to them to ensure that only non-U.S.
persons are solicited and admitted as pool participants.
Therefore, the Commission is proposing to add a safe harbor as new
Commission regulation 3.10(c)(3)(iv) for non-U.S. CPOs that have taken,
what the Commission preliminarily believes are, reasonable steps
designed to ensure that participation units in the operated offshore
pool are not being offered or sold to persons located in the United
States. Pursuant to that proposed safe harbor, a non-U.S. CPO would be
permitted to engage in the U.S. commodity interest markets on behalf of
offshore pools for which it cannot represent with absolute certainty
that all of the pool participants are offshore, consistent with the
requirements under the 3.10 Exemption, provided that such non-U.S. CPO
meets the following conditions with respect to the operated offshore
pool:
1. The offshore pool's offering materials and any underwriting or
distribution agreements include clear, written prohibitions on the
offshore pool's offering to participants located in the United States
and on U.S. ownership of the offshore pool's participation units; \42\
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\42\ The Commission notes that, for purposes of the safe harbor,
and consistent with the proposed exception for initial capital
contributions from a U.S. controlling affiliate, proposed Commission
regulation 3.10(c)(3)(iii) discussed infra, such U.S. controlling
affiliate is not considered to be a ``participant.''
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2. The offshore pool's constitutional documents and offering
materials: (a) are reasonably designed to preclude persons located in
the United States from participating therein, and (b) include
mechanisms reasonably designed to enable the CPO to exclude any persons
located in the United States who attempt to participate in the offshore
pool notwithstanding those prohibitions;
3. The non-U.S. CPO exclusively uses non-U.S. intermediaries for
the distribution of participations in the offshore pool;
4. The non-U.S. CPO uses reasonable investor due diligence methods
at the time of sale to preclude persons located in the United States
from participating in the offshore pool; and
5. The offshore pool's participation units are directed and
distributed to participants outside the United States, including by
means of listing and trading such units on secondary markets organized
and operated outside of the United States, and in which the non-U.S.
CPO has reasonably determined participation by persons located in the
United States is unlikely.
For this purpose, the Commission has preliminarily determined that
a non-U.S. intermediary would include a non-U.S. branch or office of a
U.S. entity, or a non-U.S. affiliate of a U.S. entity, provided that
the distribution takes place exclusively outside of the United States.
By satisfying the factors of the safe harbor, for example, that the
offshore pool's offering materials clearly prohibit ownership by
participants that are U.S. persons,\43\ and by using offshore
distribution channels and exchanges, the Commission preliminarily
believes that the non-U.S. CPO is exercising sufficient diligence with
respect to those circumstances within its control to demonstrate its
intention to avoid engaging with U.S. persons concerning the offered
offshore pool. Moreover, the Commission preliminarily believes that if
a non-U.S. CPO meets the five factors in the safe harbor, the absence
of U.S. participants is sufficiently ensured so as to allow reliance on
the 3.10 Exemption. As with any of the Commission's other registration
exemptions available to CPOs, whether domestic or offshore, the
Commission would expect non-U.S. CPOs claiming the 3.10 Exemption to
maintain adequate documentation to demonstrate compliance with the
terms of the safe harbor.
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\43\ See note 45, supra.
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The Commission preliminarily believes that providing a safe harbor
with appropriate conditions for non-U.S. CPOs of commodity pools,
regarding the absence of U.S. participants in their offshore pools to
avail themselves of the exemptive relief in the 3.10 Exemption, may
result in more offshore pools choosing to engage in the commodity
interest markets in the United States. Moreover, as noted above,
pursuant to section 4(d) of the Act, the Commission expressly retains
the statutory authority to conduct investigations in order to determine
compliance with the requirements or conditions of such exemption or to
take enforcement action for any violation of any provision of the CEA
or any rule, regulation or order thereunder caused by the failure to
comply with or satisfy such conditions or requirements.\44\ Moreover,
again as noted above, the Commission would retain the authority to take
enforcement action against any non-U.S. CPO claiming the 3.10 Exemption
based on their activities within the U.S. commodity interest markets.
Therefore, the Commission preliminarily believes that the safe harbor
proposed herein is an appropriate exercise of its authority pursuant to
section 4(c) of the Act.
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\44\ 7 U.S.C. 6(d).
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c. Utilizing the 3.10 Exemption Concurrent With Other Regulatory Relief
Available to CPOs
As discussed above, the Commission is proposing that the 3.10
Exemption for non-U.S. CPOs be available on a pool-by-pool basis.
Consistent with these proposed amendments, the Commission also
preliminarily believes it is appropriate to propose amendments to
explicitly provide that non-U.S. CPOs may claim the 3.10 Exemption
while that CPO also claims other registration exemptions or regulatory
exclusions with respect to other pools it operates, e.g., the de
minimis exemption under Commission regulation 4.13(a)(3),\45\ or an
exclusion from the definition of CPO under Commission regulation
4.5,\46\ or to register with respect to such pools,\47\
[[Page 35825]]
in order to address the concerns articulated by commenters to the 2018
Proposal.\48\ The Commission understands that this practice is known
colloquially as the ability to ``stack'' exemptions.
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\45\ 17 CFR 4.13(a)(3).
\46\ 17 CFR 4.5.
\47\ The Commission notes that including registration among the
provisions a non-U.S. CPO may ``stack'' with the 3.10 Exemption is
not strictly necessary, as such status is implied given the
amendments described earlier to allow the 3.10 Exemption to apply on
a pool-by-pool basis. Nevertheless, the Commission is explicitly
stating that such a status is possible to provide certainty to
affected non-U.S. CPOs.
\48\ See, e.g., AIMA, at 6; Willkie, at 6.
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Currently, the 3.10 Exemption does not have a provision that
contemplates its simultaneous use with other exemptions available under
other Commission regulations. This stands in contrast with the language
in Commission regulation 4.13(f), for example, which states that, the
filing of a notice of exemption from registration under this section
will not affect the ability of a person to qualify for exclusion from
the definition of the term `commodity pool operator' under Sec. 4.5 in
connection with its operation of another trading vehicle that is not
covered under this Sec. 4.13.\49\
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\49\ 17 CFR 4.13(f).
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With respect to those non-U.S. CPOs that operate both U.S. pools
and pools that meet the terms of the 3.10 Exemption, the Commission
preliminarily believes that such non-U.S. CPOs should have the ability
to rely on other regulatory exemptions or exclusions that they qualify
for, just like any other CPO. The Commission preliminarily believes
that the fact that the CPO of a U.S. commodity pool that otherwise
meets the criteria for its operator to claim registration relief under
Commission regulation 4.13(a)(3), for example, has also claimed the
3.10 Exemption for one or more of its offshore pools does not raise
heightened regulatory concerns regarding the operation of the U.S.
pool. The Commission has independently developed the terms under which
CPOs of U.S. commodity pools may claim registration relief, and the
fact that a non-U.S. CPO operates both offshore and U.S. commodity
pools does not undermine the rationale providing the foundation for the
Commission's other regulatory exemptions available to CPOs generally.
The Commission therefore preliminarily concludes that a non-U.S.
CPO relying upon the 3.10 Exemption for one or more of its offshore
pools should not be, by virtue of that reliance, foreclosed from
utilizing other relief generally available to CPOs of U.S. pools. Thus,
the Commission is also proposing to add Commission regulation
3.10(c)(3)(iv) to establish that a non-U.S. CPO's reliance upon the
3.10 Exemption for one or more pools will not affect that CPO's ability
to claim other exclusions or exemptions, including those in Commission
regulations 4.5 or 4.13, or to register with respect to the other pools
that it operates.
d. Affiliate Investment Exception
The Commission is also proposing to add Commission regulation
3.10(c)(3)(iii), which provides that initial capital contributed by a
non-U.S. CPO's U.S. controlling affiliate to that CPO's offshore
commodity pool would not be considered in assessing whether that pool
is an offshore pool for purposes of the 3.10 Exemption because the U.S.
controlling affiliate would not be considered a ``participant'' for
purposes of either proposed Commission regulation 3.10(c)(3)(ii) or
3.10(c)(3)(iv). For the purpose of this proposed amendment, the term
``control'' would be defined as the possession, direct or indirect, of
the power to direct or cause the direction of the management and
policies of a person, whether through the ownership of voting shares,
by contract, or otherwise.\50\
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\50\ The Commission currently uses this definition of
``control'' in its part 49 regulations on swap data reporting. See
17 CFR 49.2(a)(4). In January 2020, the Commission also proposed to
implement this definition of ``control'' in the context of cross-
border regulation of swap dealers. See Cross-Border Application of
the Registration Thresholds and Certain Requirements Applicable to
Swap Dealers and Major Swap Participants, 85 FR 952, 1002 (Jan. 8,
2020) (proposing to add the ``control'' definition at Sec.
23.23(a)(1)).
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Although the 3.10 Exemption is intended to focus the Commission's
resources on protecting U.S. participants, the Commission preliminarily
believes that the control typically exercised by a controlling
affiliate over its non-U.S. CPO affiliate should provide a meaningful
degree of protection and transparency with respect to the controlling
affiliate's contribution of initial capital to the non-U.S. CPO's
offshore commodity pool. Moreover, the majority of a CPO's compliance
obligations generally focus on customer protection through a variety of
disclosures regarding a person's participation in a pool, which is
information the controlling affiliate would likely already be in a
position to obtain independent of the Commission's regulations, thereby
obviating the need for the Commission to mandate such disclosure and
reporting.\51\
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\51\ See 17 CFR 4.22(c)(8) (providing that a CPO need not
distribute an annual report to pools operated by persons
controlling, controlled by, or under common control with the CPO,
provided that information regarding the underlying pool is contained
in the investor pool's annual financial statement).
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A controlling person must, by definition, have the corporate or
other legal authority to require the controlled CPO to provide more
information than is required by the Commission, such as detailed
information about the non-U.S. CPO's finances, management and
operations, and, more relevant to the proposal herein, access to
investment and performance information for the offshore pool.
Accordingly, the Commission preliminarily believes that due to the
fundamentally different features of the relationship between a
controlling affiliate and a non-U.S. CPO as compared to an outside
investor and a CPO, a U.S. controlling affiliate's participation,
through an initial investment, in its affiliated non-U.S. CPO's
offshore pool does not raise the same customer protection concerns as
similar investments in the same pool by unaffiliated persons located in
the United States.
Commission staff in the Division of Swap Dealer and Intermediary
Oversight (DSIO) previously granted staff no-action relief for a non-
U.S. CPO of offshore pools that received initial capital contributions
from U.S. sources affiliated with the non-U.S. CPO for a limited period
of time.\52\ Specifically, in CFTC Staff Letter 15-46, DSIO articulated
a no-action position related to initial capital contributions provided
to offshore pools operated by a non-U.S. CPO derived from the U.S.
employees of the affiliated U.S. investment advisers to the offshore
pools.\53\ In that instance, in part because the participants were
natural person employees of the affiliated U.S. investment advisers,
staff determined that it was appropriate to limit the time in which the
U.S. derived capital could remain in the offshore pools without the
non-U.S. CPO registering with the Commission.\54\
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\52\ See CFTC Staff Letter 15-46 (May 8, 2015).
\53\ Id. at 2.
\54\ Id.
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With respect to the exception proposed herein, the Commission
preliminarily believes that imposing a time limit is not necessary
where the initial investment capital is deriving not from natural
person employees, but rather the corporate funds of a U.S. controlling
affiliate. Unlike the facts presented in CFTC Staff Letter 15-46, the
Commission preliminarily believes that the control that a U.S.
controlling affiliate is able to exercise with respect to the
operations of the non-U.S. CPO and its offshore pools provides adequate
assurances that the U.S. controlling affiliate is able to obtain and
act upon
[[Page 35826]]
the information relevant to its participation in the offshore pool.\55\
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\55\ The Commission notes that certain control affiliates may be
subject to the time limitations imposed on the contribution of
initial capital to affiliated covered funds under the Volcker Rule
due to their status as banking entities. See 17 CFR 75.12. The
exemption proposed herein with respect to initial capital
contributions does not affect or negate any other limitations
imposed by other statutory or regulatory provisions applicable to
the control affiliate.
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The Commission preliminarily intends to limit the exception for
U.S. controlling affiliate capital contributions to those made at or
near a pool's inception, which generally result from commercial
decisions by the U.S. controlling affiliate, typically in conjunction
with the non-U.S. CPO, to support the offshore pool until such time as
it has an established performance history for solicitation purposes,
although the contributed capital may remain in the offshore pool for
the duration of its operations. The Commission preliminarily believes
that this limitation is appropriate to ensure that the capital is being
contributed in an effort to support the operations of the offshore pool
at a time when its viability is being tested, rather than as a
mechanism for the U.S. controlling affiliate to generate returns for
its own investors.
The Commission notes, however, that the proposed exclusion may not
be used to evade the Commission's CPO compliance requirements with
respect to offshore commodity pools. For example, a controlling
affiliate located in the U.S. could invest in its affiliated non-U.S.
CPO's offshore pool, and then solicit persons located in the U.S. for
investment in that controlling affiliate, for the purpose of providing
such investors indirect exposure to that offshore pool. Under these
circumstances, the Commission preliminarily believes that such
practices would generally constitute evasion of the Commission's
regulation of CPOs and commodity pools soliciting and serving
participants located in the U.S. and would render the non-U.S. CPO
ineligible for the 3.10 Exemption. Additionally, the Commission
preliminarily believes that U.S. controlling affiliates that are barred
from participating in the U.S. commodity interest markets should not be
permitted to gain indirect access to those markets through an
affiliated non-U.S. CPO's offshore pool as this would undermine the
purposes of such a ban. Therefore, the Commission is proposing to
include provisions in the proposed exemption to prohibit such evasive
conduct marked by either pooling of U.S. participant capital in the
U.S. controlling affiliate or the contribution of initial capital to an
offshore pool by a person subject to a statutory disqualification,
ongoing registration suspension or bar, prohibition on acting as a
principal, or trading ban with respect to participating in the U.S.
commodity interest markets.
Consistent with its authority under section 4(c) of the Act, the
Commission preliminarily believes that providing an exception for
initial capital contributions by U.S. controlling affiliates in
offshore pools operated by affiliated non-U.S. CPOs could result in
increased economic or financial innovation by non-U.S. CPOs and their
offshore pools participating in the U.S. commodity interest markets.
The Commission further preliminarily believes enabling U.S. controlling
affiliates to provide initial capital to offshore pools operated by
affiliated non-U.S. CPOs could provide such non-U.S. CPOs with the
ability to test novel trading programs or otherwise engage in proof of
concept testing with respect to innovations in the collective
investment industry that might otherwise not be possible due to a lack
of a performance history for the offered pool. For the reasons set
forth above, the Commission has preliminarily concluded that it is
appropriate to provide an exception for initial capital contributions
by U.S. controlling affiliates in offshore pools operated by affiliated
non-U.S. CPOs from the U.S. participant prohibition in the 3.10
Exemption pursuant to section 4(c) of the Act.
e. General Request for Comment
The Commission requests comment on all aspects of the Proposal.
Specifically, given the concerns regarding potential evasion of CPO
regulation using the controlling affiliate provision, the Commission
seeks comment on several potential additional conditions on the
exception that could be included in the final regulation.
1. To establish that the funds of the controlling affiliate are
being used for seeding purposes, should the exception state that the
purpose of the investment by the controlling affiliate shall be for
establishing the commodity pool and providing sufficient initial equity
to permit the pool to attract unaffiliated non-U.S. investors?
Similarly, should the exception be conditioned on the investment being
limited in time to one, two, or three years after which time the
investments of the controlling affiliate must be reduced to a de
minimis amount of the pool's capital, such as 3 or 5 percent? What
customer protection benefits would such limitations serve?
2. Regarding the nature of controlling affiliates, to protect the
U.S. persons invested therein, should the exception be limited to
entities or persons that are otherwise financial institutions that are
regulated in the United States to provide investor protections? For
example, should the exception only be available to U.S. controlling
affiliates regulated by the Securities and Exchange Commission, a
federal banking regulator, or an insurance regulator?
3. The Proposal notes that one of the reasons underlying the U.S.
controlling affiliate exception is the affiliate's likely ability to
demand that the non-U.S. CPO provide it with the information necessary
to assess the operations and performance of the offshore pool. However,
because these offshore pools are by definition non-U.S. entities and it
is not possible to ascertain with certainty whether such information
must be provided to a U.S. controlling affiliate under the laws
applicable to the non-U.S. CPO and offshore pool, should the exception
be conditioned on there being an obligation on the non-U.S. CPO that is
legally binding in its home jurisdiction to provide the U.S.
controlling affiliate with information regarding the operation of the
offshore pool by the affiliated non-U.S. CPO?
III. Reopening of Comment Period Under 2016 Proposal
On July 27, 2016, the Commission proposed to amend Commission
regulation 3.10(c) to amend the conditions under which the exemption
from registration would apply.\56\ Generally, the proposed amendment
would permit a foreign broker or persons located outside the United
States acting in the capacity of an introducing broker, commodity
trading advisor, or commodity pool operator, each as defined in
Commission regulation 1.3, to be eligible for an exemption from
registration with the Commission if the foreign broker or person, in
connection with a commodity interest transaction, only acts on behalf
of (1) persons located outside the United States, or (2) International
Financial Institutions (as defined in the proposed rule amendments),
without regard to whether such persons or institutions clear such
commodity interest transaction.
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\56\ Exemption from Registration for Certain Foreign Persons, 81
FR 51824 (Aug. 5, 2016) (the ``2016 Proposal'').
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In response to the Proposal, the Commission received six
comments,\57\ most of which were supportive of the proposal. Given the
passage of time, however, the Commission now requests
[[Page 35827]]
comment on whether it would be appropriate to finalize the 2016
Proposal along with the other amendments to Commission regulation 3.10
proposed in this release. Thus, the Commission is reopening the comment
period on all aspects of the 2016 Proposal for 60 days.
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\57\ These comment letters are on the Commission's website at:
http://comments.cftc.gov/PublicComments/CommentList.aspx?id=1724.
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In addition, with respect to the 2016 Proposal, the Commission
requests specific comment on whether Commission regulation 3.10 should
require commodity interest transactions of persons located outside of
the United States or of International Financial Institutions that are
required or intended to be cleared on a registered derivatives clearing
organization (DCO) to be submitted for clearing through a futures
commission merchant registered in accordance with section 4d of the
Act, unless such person or International Financial Institution is
itself a clearing member of such registered DCO?
IV. Related Matters
a. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires Federal agencies, in
promulgating regulations, to consider whether the rules they propose
will have a significant economic impact on a substantial number of
small entities and, if so, to provide a regulatory flexibility analysis
regarding the economic impact on those entities. Each Federal agency is
required to conduct an initial and final regulatory flexibility
analysis for each rule of general applicability for which the agency
issues a general notice of proposed rulemaking.\58\
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\58\ 5 U.S.C. 601, et seq.
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The Proposal by the Commission today would affect only CPOs. The
Commission has previously established certain definitions of ``small
entities'' to be used by the Commission in evaluating the impact of its
rules on such entities in accordance with the requirements of the
RFA.\59\ With respect to CPOs, the Commission previously has determined
that a CPO is a small entity for purposes of the RFA, if it meets the
criteria for an exemption from registration under Commission regulation
4.13(a)(2).\60\ With respect to small CPOs operating pursuant to
Commission regulation 4.13(a)(2), the Commission preliminarily believes
that, should the amendments to the 3.10 Exemption be adopted as final,
certain of those small CPOs may choose to operate additional pools
outside the United States, which could provide additional opportunities
to develop their operations not currently available to them. The
Commission notes, however, that such small CPOs would remain subject to
the total limitations on aggregate gross capital contributions and pool
participants set forth in Commission regulation 4.13(a)(2) because that
exemption is based on the entirety of the CPO's pool operations.
Because investment vehicles operated under the 3.10 Exemption remain
commodity pools under the CEA, the Commission preliminarily does not
believe that the amendments proposed herein would result in a
significant economic impact on a substantial number of small CPOs.
Further, the Commission notes that the Proposal would impose no new
obligation, significant or otherwise. Accordingly, the Chairman, on
behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b)
that the Proposal, if adopted, will not have a significant economic
impact on a substantial number of small entities.
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\59\ See, e.g., Policy Statement and Establishment of
Definitions of ``Small Entities'' for Purposes of the Regulatory
Flexibility Act, 47 FR 18618, 18620 (Apr. 30, 1982).
\60\ Id. at 18619-20. Commission regulation 4.13(a)(2) exempts a
person from registration as a CPO when: (1) None of the pools
operated by that person has more than 15 participants at any time,
and (2) when excluding certain sources of funding, the total gross
capital contributions the person receives for units of participation
in all of the pools it operates or intends to operate do not, in the
aggregate, exceed $400,000. See 17 CFR 4.13(a)(2).
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b. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (PRA) imposes certain
requirements on Federal agencies, including the Commission, in
connection with their conducting or sponsoring any collection of
information, as defined by the PRA.\61\ An agency may not conduct or
sponsor, and a person is not required to respond to, a collection of
information unless it displays a currently valid control number. The
Commission has preliminarily determined that the proposed amendments,
if adopted, will not impose any new recordkeeping or information
collection requirements, or other collections of information that
require approval of the Office of Management and Budget (OMB) under the
PRA.
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\61\ 44 U.S.C. 3501, et seq.
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The Commission invites the public and other interested parties to
comment on this PRA determination. Pursuant to 44 U.S.C. 3506(c)(2)(B),
the Commission generally solicits comments in order to: (1) Evaluate
whether a proposed collection of information is necessary for the
proper performance of the functions of the Commission, including
whether the information will have practical utility; (2) evaluate the
accuracy of the Commission's estimate of the burden of a proposed
collection of information; (3) determine whether there are ways to
enhance the quality, utility, and clarity of the information to be
collected; and (4) mitigate the burden of a collection of information
on those who are to respond, including through the use of automated
collection techniques or other forms of information technology. The
Commission specifically invites public comment on the accuracy of its
estimate that no additional information collection requirements or
changes to existing collection requirements would result from the
regulatory amendments proposed herein.
Comments may be submitted directly to the Office of Information and
Regulatory Affairs (OIRA), by fax at (202) 395-6566 or by email at
[email protected]. Please provide the Commission with a copy
of submitted comments, so that all comments can be summarized and
addressed in the final rule preamble. Refer to the ADDRESSES section of
this notice of proposed rulemaking for comment submission instructions
to the Commission. OMB is required to make a decision concerning a
collection of information between 30 and 60 days after publication of
this document in the Federal Register. Therefore, a comment is best
assured of having its full effect if OMB receives it within 30 days of
publication.
c. Cost-Benefit Considerations
Section 15(a) of the Act requires the Commission to consider the
costs and benefits of its actions before issuing new regulations under
the CEA.\62\ Section 15(a) of the Act further specifies that the costs
and benefits of the proposed rules shall be evaluated in light of five
broad areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness and
financial integrity of the futures markets; (3) price discovery; (4)
sound risk management practices; and (5) other public interest
considerations. The Commission may, in its discretion, give greater
weight to any of the five enumerated areas of concern and may, in its
discretion, determine that, notwithstanding its costs, a particular
rule is necessary or appropriate to protect the public interest or to
effectuate any of the provisions or to accomplish any of the purposes
of the CEA. The Commission invites public comment on its cost-benefit
considerations.
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\62\ 7 U.S.C. 19(a).
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[[Page 35828]]
As explained above, the current 3.10 Exemption provides relief from
registration to non-U.S. CPOs operating offshore pools with foreign
participants.\63\ The 3.10 Exemption provides that it is only available
to non-U.S. CPOs acting on behalf of offshore commodity pools. In a
prior proposal that discussed the 3.10 Exemption, the Commission stated
that the current registration exemption is not available on a pool-by-
pool basis, meaning that a non-U.S. CPO would be unable to claim the
exemption with respect to its offshore pools meeting the specified
criteria for the 3.10 Exemption while maintaining CPO registration with
respect to other pools--e.g., pools, regardless of domicile, with U.S.
participants. Therefore, non-U.S. CPOs that operate a mix of some
offshore pools that are not available to U.S. participants and other
pools that are offered and sold to U.S. participants would have to
either register and list all of their operated pools or claim an
alternative exemption or exclusion. One such available source of
exemptive relief is Staff Advisory 18-96 (Advisory 18-96), which,
although still requiring registration of the CPO, does provide relief
from the majority of the compliance obligations set forth in part 4 of
the Commission's regulations.\64\
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\63\ See Section I, supra.
\64\ CFTC Staff Advisory 18-96 (Apr. 11, 1996).
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The Commission is proposing several amendments to the current 3.10
Exemption. Specifically, the Commission is proposing to amend the 3.10
Exemption such that non-U.S. CPOs may rely on that exemption on a pool-
by-pool basis through proposed Commission regulation 3.10(c)(3)(ii).
Next, proposed Commission regulation 3.10(c)(3)(iii) would make it
clear that a non-U.S. CPO's eligibility to rely upon the 3.10 Exemption
is unaffected by any contributions the non-U.S. CPO's offshore pools
might receive from the non-U.S. CPO's U.S. controlling affiliate. The
Commission is also proposing Commission regulation 3.10(c)(3)(iv),
which would establish a regulatory safe harbor for those non-U.S. CPOs
that cannot represent with absolute certainty that there are no U.S.
participants in the operated offshore pool. Finally, the Commission is
proposing Commission regulation 3.10(c)(3)(v), which would permit non-
U.S. CPOs to claim an available exemption from registration, claim an
exclusion, or register with respect to the other pools they operate.
The proposed amendments would grant non-U.S. CPOs relief that will
likely generate costs and benefits. The baseline against which these
costs and benefits are compared is the regulatory status quo set forth
in current Commission regulation 3.10(c)(3).
The consideration of costs and benefits below is based on the
understanding that the markets function internationally, with many
transactions involving U.S. firms taking place across international
boundaries; with some Commission registrants being organized outside of
the United States; with some leading industry members typically
conducting operations both within and outside the United States; and
with industry members commonly following substantially similar business
practices wherever located. Where the Commission does not specifically
refer to matters of location, the discussion of costs and benefits
below refers to the effects of this proposal on all activity subject to
the proposed amended regulations, whether by virtue of the activity's
physical location in the United States or by virtue of the activity's
connection with activities in or effect on U.S. commerce under CEA
section 2(i).\65\
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\65\ 7 U.S.C. 2(i).
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i. Proposed Commission Regulation 3.10(c)(3)(ii): Providing That the
3.10 Exemption May Be Claimed on a Pool-by-Pool Basis
Specifically, pursuant to the Proposal, a non-U.S. CPO would be
able to claim the 3.10 Exemption from registration with respect to its
eligible offshore pools, while either registering as a CPO or claiming
another available exemption or exclusion for its other pools that are
either located in the U.S., or that solicit and/or accept as
participants persons located within the U.S. Absent the proposed
amendment, such CPOs would face some costs and compliance burdens
associated with the operation of their offshore pools,\66\ despite the
Commission's historical focus on prioritizing customer protection with
respect to persons located in the United States. For example, certain
registered U.S. and non-U.S. CPOs file self-executing notices pursuant
to Advisory 18-96 with respect to their offshore pools. The Advisory
provides compliance relief with respect to all of the pool-based
disclosures required under the Commission's regulations, as well as
many of the reporting and recordkeeping obligations that otherwise
would apply to registered CPOs, with the exception of the requirement
to file Form CPO-PQR under Commission regulation 4.27. The relief
pursuant to Advisory 18-96 also allows qualifying, registered U.S. CPOs
to maintain their offshore pool's original books and records at the
pool's offshore location, rather than at the CPO's main business office
in the United States.\67\
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\66\ As discussed, infra, certain CPOs may be eligible for
significant compliance relief pursuant to Advisory 18-96.
\67\ See note 28, supra.
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Currently, based on the notices filed pursuant to Advisory 18-96,
the Commission is aware of 23 non-U.S. CPOs that operate 84 offshore
pools and 20 U.S. CPOs that operate 88 offshore pools. In total, 43
CPOs file 18-96 notices. However, the Commission preliminarily believes
that there are likely a number of registered non-U.S. CPOs that do not
list their offshore pools with the Commission, and, therefore, do not
claim relief under Advisory 18-96. Although these exemption notices
must be filed by hardcopy, the Commission believes the administrative
costs are low.\68\ CPOs must employ at least one staff-person to manage
and file the one-time notice under Advisory 18-96. For a notice under
Advisory 18-96 to be effective, the CPO must provide, among other
things, business-identifying and contact information; representations
that its principals are not statutorily disqualified; enumerated rules
from which the CPO seeks relief; and contact information for person(s)
who will maintain offshore books and records.\69\ Under the Proposal,
the current 23 registered non-U.S. CPOs would be able to delist their
offshore pools and no longer file 18-96 notices acknowledging that they
operate one of the 84 offshore pools. Upon delisting of such pools,
those registered non-U.S. CPOs would no longer have to include their
offshore pools in their Form CPO-PQR filings, which will result in cost
savings for those CPOs. The 20 U.S. CPOs, however, would continue to
claim relief under Advisory 18-96, because they remain ineligible for
the 3.10 Exemption due to their location in the United States.
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\68\ See https://www.nfa.futures.org/members/cpo/cpo-exemptions.html.
\69\ See note 28, supra.
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Currently, one way that a registered CPO can avoid the requirement
to list its offshore pools with the Commission is to establish a
separate, foreign-domiciled CPO for all of the pools that are eligible
for the 3.10 Exemption. The Commission preliminarily believes that the
Proposal would eliminate the incentive to establish a separately
organized CPO solely to operate the pools that would qualify for the
3.10 Exemption. The Commission preliminarily believes, however, that
the
[[Page 35829]]
financial expenses associated with establishing a foreign CPO varies
depending on the operating size and structure of the registered CPO.
The Commission further notes that incentives to establish additional
CPOs may also be affected by the amount of the financial outlay to
establish foreign-domiciled CPOs given that set-up costs--such as,
costs to pay staff and experts; expenses for business licenses and
registrations; costs to draft operational and disclosure documents;
fees to establish technological services--would be expected to vary by
jurisdiction. Therefore, although the Commission believes that there
are costs associated with establishing a separate, foreign-domiciled
CPO, the Commission preliminarily believes that such costs may be
marginal and would be dependent on the organization and domicile of the
registered CPO.
The Commission expects that amending the 3.10 Exemption such that
non-U.S. CPOs may claim the exemption on a pool-by-pool basis would
result in such CPOs saving the costs associated with forming and
maintaining a new CPO to operate the other pools in its overall
structure, and would thereby remove unnecessary complexity in pool
operations. Therefore, by amending the 3.10 Exemption such that non-
U.S. CPOs may claim the exemption on a pool-by-pool basis, the
Commission preliminarily believes that it would eliminate a large
portion of CFTC-registered, non-U.S. CPOs' compliance costs associated
with the operation of their offshore pools, which by their very
characteristics implicate fewer of the Commission's regulatory
interests. This is only for U.S. compliance costs, as non-U.S. CPOs
would still have compliance costs with non-US regulatory regimes.
Moreover, the Commission preliminarily believes that this targeting of
its CPO oversight appropriately recognizes the global nature of the
asset management industry.
The Commission also does not expect that non-U.S. CPOs would
experience any increased costs associated with the amendments such that
the 3.10 Exemption may be claimed on a pool-by-pool basis. As noted
above, the Commission is proposing to permit the exemption to be
claimed without any filing by the non-U.S. CPO. This is no different
from how the current exemption is implemented. The current terms of the
3.10 Exemption would require a CPO to monitor the operations of its
offshore pools to ensure that the pools are not offered in the United
States and that they do not have any participants located in the United
States. Under the terms of the Proposal, such CPOs would continue to be
required to engage in such monitoring.
The Commission preliminarily believes that there may be some loss
of information available to the public regarding the existence of the
offshore pools operated by registered non-U.S. CPOs because such
offshore pools would no longer be listed with the Commission, and
consequently, the pools' existence and identifying information would
not be publicly disclosed on NFA's BASIC database. The Commission has
preliminarily concluded that this loss of information would have a
minimal impact on the general public because persons located within the
United States would typically not be permitted by the non-U.S. CPO to
participate in such pools.
ii. Proposed Commission Regulation 3.10(c)(3)(iv): Regulatory Safe
Harbor for Non-U.S. CPOs With Possible Inadvertent U.S. Participants in
Offshore Pools
As explained previously, the Commission is proposing Commission
regulation 3.10(c)(3)(iv) to provide a regulatory safe harbor for those
non-U.S. CPOs who, due to the structure of their offshore pools, cannot
represent with absolute certainty that there are no U.S. participants
in their offshore pools, provided that such non-U.S. CPOs take certain
enumerated actions to ensure that no U.S. persons are participating in
the offshore pool. The Commission preliminarily believes that proposed
Commission regulation 3.10(c)(3)(iv) benefits non-U.S. CPOs by making
the registration relief provided under the 3.10 Exemption more widely
available by recognizing the informational limitations inherent in
certain pool structures. Therefore, the Commission preliminarily
believes that this proposed safe harbor could result in more non-U.S.
CPOs relying upon the 3.10 Exemption with respect to more pools. At
this time, the Commission lacks sufficient information to quantify the
number of additional non-U.S. CPOs and offshore pools that may claim
relief under proposed Commission regulation 3.10(c)(3)(iv) because the
Commission does not currently receive information of the nature
necessary to determine which offshore pools currently listed with the
Commission are offered and sold solely to offshore participants and
what subset of those pools may have participation units traded in the
secondary market. Given, however, that exchange traded commodity pools
currently comprise less than 1% of the total number of pools listed
with the Commission, the Commission preliminarily believes that it is
reasonable to estimate the number of offshore pools operated in a
similar manner to be equally small.
The Commission preliminarily believes that non-U.S. CPOs that would
be eligible for registration relief under proposed Commission
regulation 3.10(c)(3)(iv) would avail themselves of that relief. This
could result in the Commission receiving less information regarding the
operation of such offshore pools operated pursuant to the proposed
regulatory safe harbor. As noted above, the Commission preliminarily
believes that the amount of information lost as a result of the
deregistration of such non-U.S. CPOs and associated delisting of their
eligible offshore pools would be minimal due to the expected small
number of CPOs and pools relative to the total population of registered
CPOs and listed pools.
The Commission also preliminarily expects that there may be some
inadvertent U.S. participants in offshore pools who would lose the
customer protection afforded by part 4 of the Commission's regulations
should a non-U.S. CPO decide to delist its offshore pools and claim
relief under the 3.10 Exemption, given the clarity and certainty
provided by the regulatory safe harbor. The Commission preliminarily
believes that the enumerated actions comprising the regulatory safe
harbor provide assurance that the number of U.S. persons so impacted
would be small. Moreover, the Commission preliminarily believes that
such U.S. persons, to the extent that they are aware that they are
participating in what is known to be an offshore pool through the
purchase of participation units sold in an offshore secondary market,
may not expect to benefit from the customer protection provisions in
part 4 of the Commission's regulations, but would instead expect to
rely upon the regulatory protections of the offshore pool's home
jurisdiction.
iii. Proposed Commission Regulation 3.10(c)(3)(v): Utilizing the 3.10
Exemption Concurrent With Other Available Exclusions and Exemptions
As explained above, the Commission is also proposing to add
Commission regulation 3.10(c)(3)(v) such that non-U.S. CPOs may rely
upon the 3.10 Exemption concurrent with other exemptions and
exclusions, or, alternatively, registration under the Commission's
regulations. The Commission preliminarily believes that proposed
Commission regulation 3.10(c)(3)(v) therefore benefits non-U.S. CPOs
through consistent treatment of
[[Page 35830]]
CPOs of pools that are operated in a substantively identical manner
with respect to their use of derivatives or their size, regardless of
where the CPO is based. The Commission has also preliminarily
determined that these proposed amendments will benefit the non-U.S. CPO
industry generally by providing certainty regarding the ability to
simultaneously rely upon the 3.10 Exemption and other exclusions and
exemptions available under the Commission's regulations. The Commission
also notes that this proposed amendment is consistent with other
instances in its CPO regulatory program, where the Commission already
permits CPOs to claim more than one type of exemption or exclusion or
to register with respect to the variety of commodity pools operated by
them.\70\
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\70\ See, e.g., 17 CFR 4.13(e)(2) and 4.13(f).
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The Commission further preliminarily believes that by clarifying
the permissibility of using Commission regulation 4.13 exemptions, for
example, in conjunction with the 3.10 Exemption, non-U.S. CPOs may be
more likely to claim the relief under Commission regulation 4.13 for
their eligible pools, rather than registering and listing those pools.
The Commission preliminarily concludes that clearly establishing the
availability of other exemptions and exclusions or, alternatively,
registration with respect to the operation of certain pools offered or
sold to persons within the United States will further enable the
Commission to more efficiently deploy its resources in the oversight of
CPOs and commodity pools that it has previously determined more fully
implicate its regulatory concerns and interests under the CEA.
If more non-U.S. CPOs claim exemptions under Commission regulation
4.13(a)(3), for example, for some of their U.S. facing pools as a
result of the Proposal, this could result in pools that were previously
listed and associated with a CPO registration being delisted. Under
these circumstances, the Commission would, as a result, no longer
receive financial reporting with respect to those pools, including on
Form CPO-PQR. Because these commodity pools would in fact already be
operated consistent with an existing exemption or exclusion, and
because the Commission has previously determined that pools operated in
such a manner generally do not require a registered CPO, the Commission
has preliminarily determined that any resulting loss of insight into
such pools and their CPOs would also be consistent with the
Commission's overall regulatory policy concerning CPOs and commodity
pools.\71\
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\71\ The Commission notes that it retains special call authority
with respect to those CPOs claiming an exemption from registration
pursuant to Commission regulation 4.13, which enables the Commission
to obtain additional information regarding the operation of
commodity pools by such exempt CPOs. See 17 CFR 4.13(c)(iii).
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iv. Proposed Sec. 3.10(c)(3)(iii): Exclusion of Controlling Affiliate
Investments in Offshore Pools From the 3.10 Exemption Eligibility
Determination
The Commission is also proposing to permit non-U.S. CPOs to rely
upon the 3.10 Exemption for the operation of an offshore pool, even if
a controlling affiliate within the United States provides initial
capital for the offshore pool. Absent the relief provided by proposed
Commission regulation 3.10(c)(3)(iii), a non-U.S. CPO of an offshore
pool receiving initial capital from a controlling affiliate within the
U.S. would generally be required to register as a CPO and list that
pool with the Commission, unless another exemption or exclusion was
available. As a registered CPO with respect to that offshore pool, the
non-U.S. CPO would then be required to comply with the compliance
obligations set forth in part 4 of the Commission's regulations.
As discussed previously, the Commission has preliminarily concluded
that participation in an offshore pool by a U.S. controlling affiliate
does not raise the same regulatory concerns as would an investment in
the same pool by an unaffiliated participant located within the United
States. In addition to the reasons outline above, the Commission
preliminarily believes that this proposed relief or condition to the
proposed 3.10 Exemption would provide regulatory relief for a small
number of currently-registered CPOs. Based on the number of claims
filed under Advisory 18-96, there are 23 non-U.S. CPOs that operate 84
offshore commodity pools. The Commission is unaware, however, of
whether any of the offshore pools operated by those non-U.S. CPOs
actually received initial capital contributions from a U.S. controlling
affiliate, in part, because the Commission does not collect such
information. Nevertheless, because of the small number of claims by
non-U.S. CPOs under Advisory 18-96, the Commission preliminarily
believes that the number of these CPOs that would be subject to
proposed Commission regulation 3.10(c)(3)(iii) would be less than the
23. The Commission preliminarily believes that there may be an unknown
number of registered non-U.S. CPOs that have never listed their
offshore pools with the Commission, and hence did not seek relief under
the Advisory. Therefore, the total number of non-U.S. CPOs utilizing
this exemption could also be higher. In addition, as a result of the
Commission being unware of the current number of offshore pools
operated by a non-U.S. CPO receiving seed capital from a U.S.
controlling affiliate, it is unable to predict how many pools will
utilize this proposed exclusion in the future, if this Proposal is
finalized.
The Commission also preliminarily believes that this proposed
amendment would result in reduced costs for non-U.S. CPOs with initial
capital contributions from U.S. controlling affiliates by removing such
investments from consideration for 3.10 Exemption eligibility, thereby
eliminating any registration and compliance costs for such pools. The
proposed amendment would, however, result in U.S. controlling
affiliates not being able to rely upon the protections provided by CPO
registration and by part 4 of the Commission's regulations, with
respect to their investments in an offshore pool operated by their
affiliated non-U.S. CPO.\72\ The Commission preliminarily believes that
this loss would be mitigated by such a U.S. controlling affiliate's
ability to exercise control over the operations of the affiliated non-
U.S. CPO, and thereby obtain whatever information regarding the
offshore pool a U.S. controlling affiliate may deem material to its
investment. Moreover, the Commission preliminarily believes this
approach is consistent with the Commission's focus on protecting U.S.
investors participating in commodity pools and recognizes that U.S.
controlling affiliates may also be regulated by other federal and state
authorities.
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\72\ For example, a U.S. controlling affiliate would not be able
to rely upon the Commission's part 4 regulations to require its
affiliated non-U.S. CPO to provide the controlling affiliate with
disclosures and reporting generally mandated by those rules.
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In the event, should this proposal be finalized, that a non-U.S.
CPO has listed one or more offshore pools with the Commission due to
the fact that the offshore pool received initial capital contributions
from a U.S. controlling affiliate, and such non-U.S. CPO determines to
delist the offshore pool in question and instead rely upon the revised
3.10 Exemption, the Commission would as a result no longer receive
financial reporting with respect to such pool, including on Form CPO-
PQR. Because, however, the Commission has preliminarily determined that
initial capital
[[Page 35831]]
contributions by a U.S. controlling affiliate do not raise the same
customer protection concerns as capital received from other U.S.
participants, the Commission has preliminarily determined that any
resulting loss of insight into such pools and their CPOs would also be
consistent with the Commission's overall regulatory policy concerning
CPOs and commodity pools.
v. Section 15(a) Factors
1. Protection of Market Participants and the Public
The Commission preliminarily believes that the Proposal would not
have a material negative effect on the protection of market
participants and the public. The proposed amendments enhance the
Commission ability to focus its efforts on protecting U.S. investors.
The Commission will continue to receive identifying information from
U.S. CPOs operating offshore pools and pools offered to U.S. investors.
Regarding a non-U.S. CPO whose offshore pools receive initial capital
contributions from a controlling affiliate in the United States, the
Commission preliminarily believes that although those offshore pools
may no longer be subject to part 4 of the Commission's regulations,
controlling affiliates, by virtue of their control over the non-U.S.
CPO, need not be as reliant upon the customer protection provided by
compliance with the Commission's regulations. The Commission also
preliminarily expects that some U.S. participants in offshore pools
operated pursuant to the regulatory safe harbor may also lose the
customer protections afforded by part 4 of the Commission's
regulations; however, the Commission preliminarily expects the number
of such U.S persons to be small due to the criteria required for
reliance upon the safe harbor.
2. Efficiency, Competitiveness and Financial Integrity of the Futures
Markets
The Commission has not identified any impact that the Proposal
would have on the efficiency, competitiveness and financial integrity
of the futures markets.
3. Price Discovery
The Commission has not identified any particular impact that the
Proposal would have on price discovery.
4. Sound Risk Management Practices
The Commission has not identified any impact that the Proposal
would have on sound risk management practices.
5. Other Public Interest Considerations
The Commission has not identified any other public interest
considerations impacted by the Proposal beyond those preliminarily
identified as part of its analysis supporting the Commission's exercise
of its authority under section 4(c) of the Act.
d. Anti-Trust Considerations
Section 15(b) of the Act requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any Commission
rule or regulation (including any exemption under CEA section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule, or regulation of
a contract market or registered futures association established
pursuant to section 17 of the Act.\73\ The Commission believes that the
public interest to be protected by the antitrust laws is generally to
protect competition.
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\73\ 7 U.S.C. 19(b).
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The Commission has considered the Proposal to determine whether it
is anticompetitive and has preliminarily identified no anticompetitive
effects. The Commission requests comment on whether the Proposal is
anticompetitive and, if it is, what the anticompetitive effects are.
Because the Commission has preliminarily determined that the
Proposal is not anticompetitive and has no anticompetitive effects, the
Commission has not identified any less anticompetitive means of
achieving the purposes of the Act. The Commission requests comment on
whether there are less anticompetitive means of achieving the relevant
purposes of the Act that would otherwise be served by adopting the
Proposal.
vi. Request for Comment
The Commission is seeking comment on all aspects of the costs and
benefits associated with this Proposal. The Commission specifically
seeks comment regarding the treatment of U.S. CPOs operating both U.S.
and offshore pools by foreign regulatory bodies.
List of Subjects in 17 CFR Part 3
Consumer protection, Definitions, Foreign futures, Foreign options,
Registration requirements.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR part 3 as follows:
PART 3--REGISTRATION
0
1. The authority citation for part 3 is revised to read as follows:
Authority: 5 U.S.C. 522, 522b; 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1,
6c, 6d, 6e, 6f, 6g, 6h, 6i, 6k, 6m, 6n, 6o, 6p, 6s, 8, 9, 9a, 12,
12a, 13b, 13c, 16a, 18, 19, 21, and 23.
0
2. Amend Sec. 3.10 by:
0
a. Revising paragraph (c)(3)(i);
0
b. Redesignating paragraph (c)(3)(ii) as paragraph (c)(3)(v);
0
c. Adding new paragraphs (c)(3)(ii) through (iv);
0
d. Revising newly redesignated paragraph (c)(3)(v), and
0
e. Adding paragraph (c)(3)(vi).
The revisions and additions read as follows:
Sec. 3.10 Registration of futures commission merchants, retail
foreign exchange dealers, introducing brokers, commodity trading
advisors, commodity pool operators, swap dealers, major swap
participants, and leverage transaction merchants.
* * * * *
(c) * * *
(3)(i) A person located outside the United States, its territories
or possessions engaged in the activity of: An introducing broker, as
defined in Sec. 1.3 of this chapter; or a commodity trading advisor,
as defined in Sec. 1.3 of this chapter, in connection with any
commodity interest transaction executed bilaterally or made on or
subject to the rules of any designated contract market or swap
execution facility only on behalf of persons located outside the United
States, its territories or possessions, is not required to register in
such capacity provided that any such commodity interest transaction is
submitted for clearing through a futures commission merchant registered
in accordance with section 4d of the Act.
(ii) A person located outside the United States, its territories or
possessions engaged in the activity of a commodity pool operator, as
defined in Sec. 1.3 of this chapter, in connection with any commodity
interest transactions that are executed bilaterally or made on or
subject to the rules of any designated contract market or swap
execution facility, is not required to register in such capacity when
such transactions are executed on behalf of a commodity pool the
participants of which are all located outside the United States, its
territories or possessions, and provided that, any such commodity
interest transaction is submitted for clearing through a futures
commission merchant registered in accordance with section 4d of the
Act.
(iii) With respect to paragraphs (c)(3)(ii) and (iv) of this
section, initial
[[Page 35832]]
capital contributed to a commodity pool by an affiliate, as defined by
Sec. 4.7(a)(1)(i) of this chapter, that controls, as defined by Sec.
49.2(a)(4) of this chapter, the pool's commodity pool operator shall
not be a ``participant'' for purposes of determining whether such
commodity pool operator is executing commodity interest transactions on
behalf of a commodity pool, the participants of which are all located
outside of the United States, its territories or possessions, provided
that:
(A) The control affiliate and its principals are not subject to a
statutory disqualification, ongoing registration suspension or bar,
prohibition on acting as a principal, or trading ban with respect to
participating in commodity interest markets in the United States, its
territories or possessions; and
(B) Interests in the control affiliate are not marketed as
providing access to trading in commodity interest markets in the United
States, its territories or possessions.
(iv) With respect to paragraph (c)(3)(ii) of this section, a
commodity pool operated by a person located outside the United States,
its territories or possessions shall be considered to be satisfying the
terms of paragraph (c)(3)(ii) of this section if:
(A) The commodity pool is organized and operated outside of the
United States, its territories or possessions;
(B) The commodity pool's offering materials and any underwriting or
distribution agreements include clear, written prohibitions on the
commodity pool's offering to participants located in the United States
and on U.S. ownership of the commodity pool's participation units;
(C) The commodity pool's constitutional documents and offering
materials are reasonably designed to preclude persons located in the
United States from participating therein and include mechanisms
reasonably designed to enable its operator to exclude any persons
located in the United States who attempt to participate in the offshore
pool notwithstanding those prohibitions;
(D) The commodity pool operator exclusively uses non-U.S.
intermediaries for the distribution of participations in the commodity
pool;
(E) The commodity pool operator uses reasonable investor due
diligence methods at the time of sale to preclude persons located in
the United States from participating in the commodity pool; and
(F) The commodity pool's participation units are directed and
distributed to participants outside the United States, including by
means of listing and trading such units on secondary markets organized
and operated outside of the United States, and in which the commodity
pool operator has reasonably determined participation by persons
located in the United States is unlikely.
(v) Claiming an exemption under paragraph (c)(3)(ii) of this
section will not affect the ability of a person to register with the
Commission or qualify for and/or claim an exclusion or exemption
otherwise available under Sec. 4.5 or 4.13 of this chapter, with
respect to the operation of a qualifying commodity pool or trading
vehicle not covered by the relief in this section.
(vi) A person acting in accordance with paragraph (c)(3)(i) or (ii)
of this section remains subject to section 4o of the Act, but otherwise
is not required to comply with those provisions of the Act and of the
rules, regulations and orders thereunder applicable solely to any
person registered in such capacity, or any person required to be so
registered.
* * * * *
Issued in Washington, DC, on June 1, 2020, by the Commission.
Robert Sidman,
Deputy Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Exemption From Registration for Certain Foreign Persons
Acting as Commodity Pool Operators of Offshore Commodity Pools--
Commission Voting Summary, Chairman's Statement, and Commissioners'
Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Supporting Statement of Chairman Heath P. Tarbert
In his second inaugural address in 1893, President Grover
Cleveland remarked that ``[u]nder our scheme of government the waste
of public money is a crime against the citizen.'' \1\ The CFTC is a
taxpayer-funded agency, and Congress expects us to deploy our
resources to serve the needs of American taxpayers. That is why as
Chairman and Chief Executive, I have sought to revisit our agency's
regulations where there does not appear to be a clear connection to
furthering the interests of the United States or our citizens.
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\1\ Second Inaugural Address of Grover Cleveland (Mar. 4, 1893),
reprinted in American History Through Its Greatest Speeches: A
Documentary History of the United States 278 (Courtney Smith, et
al., eds. 2016).
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The CFTC's framework for regulating foreign commodity pool
operators (``CPOs'') protects U.S. investors who put their money in
commodity investment funds run from outside the United States. But,
in some instances, the only benefit of CFTC regulation of offshore
CPOs is to foreign investors. There is no statutory mandate for the
CFTC to regulate funds never offered or sold to U.S. investors. To
do so absent a compelling reason would be--in President Cleveland's
words--a waste of public money.
Consequently, I am pleased to support today's proposal to amend
the exemption for CPOs in regulation 3.10(c) (``3.10 Exemption'').
If adopted, the proposal would eliminate the potential need for the
CFTC to require the registration and oversight of non-U.S. CPOs
whose pools have no U.S. investors. The proposal would additionally
exempt U.S.-based affiliates of fund sponsors who put seed money
into offshore funds that have only foreign investors. In so doing,
the proposal would provide much-needed regulatory flexibility for
non-U.S. CPOs operating offshore commodity pools, without
compromising the CFTC's mission to protect U.S. investors.
Exemption for Foreign CPOs Sponsoring Funds Without U.S. Investors
The proposal would amend the conditions under which a foreign
CPO, in connection with commodity interest transactions on behalf of
persons located outside the United States, would qualify for an
exemption from CPO registration and regulation with respect to that
offshore pool. Specifically, through amendments to our regulation
3.10(c), a non-U.S. CPO would be able to claim an exemption from
registration for its qualifying offshore commodity pools, without
being required to register as a CPO with respect to the operation of
other commodity pools.\2\
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\2\ The proposal also would add a safe harbor as new regulation
3.10(c)(3)(iv) for non-U.S. CPOs that have taken what the Commission
preliminarily believes are reasonable steps designed to ensure that
participation units in the operated offshore pool are not being
offered or sold to persons located in the United States.
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Absent a compelling reason, the CFTC should be focused on U.S.
markets and U.S. investors, and refrain from extending our reach
outside the United States.\3\ The protection of non-U.S. customers
of non-U.S. firms is best left to foreign regulators with the
[[Page 35833]]
relevant jurisdiction and mandate.\4\ Therefore, I believe it is
appropriate for the proposed rule to allow foreign CPOs to rely on
the 3.10 Exemption for their foreign commodity pools when they have
no U.S. investors. Where a foreign CPO does have U.S. investors,
other exemptions or exclusions from registration might be available.
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\3\ For example, section 2(i) of the Commodity Exchange Act
provides that the swap provisions of Title VII of the Dodd-Frank Act
shall not apply to activities outside the United States unless those
activities (1) have a direct and significant connection with
activities in, or effect on, commerce of the United States; or (2)
contravene such rules or regulations as the Commission may prescribe
or promulgate as are necessary or appropriate to prevent the evasion
of Title VII. In interpreting this provision, the Commission has
taken the position that ``[r]ather than exercising its authority
with respect to swap activities outside the United States, the
Commission will be guided by international comity principles and
will focus its authority on potential significant risks to the U.S.
financial system.'' Cross-Border Application of the Registration
Thresholds and Certain Requirements Applicable to Swap Dealers and
Major Swap Participants, 85 FR 952, 955 (Jan. 8, 2020).
\4\ The Commission also cited this policy position in the
initial proposal for what ultimately became Commission regulation
3.10(c)(3)(i). See 72 FR 15637, 15638 (Apr. 2, 2007).
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Unfortunately, under a strict construction of the current rule,
if a foreign CPO has one fund with U.S. investors, then the foreign
CPO must register all its funds or rely on some other exemption
besides the 3.10 Exemption. This ``all or nothing'' reading of the
rule has produced two competing consequences--neither of which makes
for good regulatory policy. First, if the CPO chooses to register
all its funds, the CFTC ends up regulating some foreign-based funds
without any U.S. investors. Second, if the CPO refuses to register
any of its funds, then U.S. investors are effectively denied the
liquidity and investment opportunities offered by foreign commodity
pools.
In the last decade, statutory and regulatory developments have
produced a growing mismatch between the Commission's stated policy
purposes underlying the 3.10 Exemption (that focus the CFTC's
resources on the protection of U.S. persons) and the strict
construction of the 3.10 Exemption (that leads to its ``all or
nothing'' application). To address this mismatch, today's proposal
would amend the 3.10 Exemption to align the plain text of the
exemption with our longstanding policy goal of regulating only
foreign CPOs that offer their funds to U.S. investors. In effect,
the Commission's walk would finally conform to our talk.\5\
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\5\ Apart from policy incoherence inside the CFTC, the mismatch
has also caused confusion among CPOs and their investors. A number
of foreign CPOs have not adopted the strict ``all or nothing''
reading of the 3.10 Exemption, but have instead quite sensibly
latched on to the Commission's stated policy behind the rule to
conclude that a foreign CPO may rely on the current 3.10 Exemption
for non-U.S. pools with only non-U.S. investors even if the foreign
CPO operates other non-U.S. pools with U.S. investors. Given that
the confusion largely stems from the Commission's own doing, I would
not support any enforcement action against foreign CPOs whose
interpretation followed the spirit, if not the letter, of the 3.10
Exemption. Furthermore, today's proposal, if adopted, would
vindicate their reading.
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Affiliate Investment Exemption
In addition to ensuring the CFTC's resources are focused on
commodity pools with U.S. investors, we must also strive to protect
those who are truly arms-length, third-party investors. To that end,
the proposal would permit certain U.S. control affiliates of a non-
U.S. CPO to contribute capital to that CPO's offshore pools as part
of the initial capitalization without rendering the non-U.S. CPO
ineligible for the 3.10 Exemption. In other words, the proposal
would simply allow a U.S. parent company of a foreign CPO to invest
in what is effectively its own offshore fund, without triggering
registration requirements.
It is hard to imagine how an entity that ultimately controls a
given foreign CPO could lack a sufficient degree of transparency
with respect to its own contribution of initial capital to an
offshore commodity pool run by that same foreign CPO. In short, a
U.S. controlling affiliate's initial investment in its affiliated
non-U.S. CPO's offshore pool does not raise the same investor
protection concerns as similar investments in the same pool by
unaffiliated persons located in the United States. In many cases,
moreover, the parent company is itself regulated by other U.S.
regulators--for instance, state insurance departments in the case of
insurance companies that wish to deploy their own general account
assets as they best see fit, in keeping with their separate
regulatory regimes. Accordingly, I see no reason to deploy the
limited, taxpayer-funded resources of the CFTC to protect U.S.
parents of foreign CPOs who are far better positioned than our
federal agency to safeguard their own interests.
Appendix 3--Supporting Statement of Commissioner Brian Quintenz
I am pleased to support today's proposal to amend the
Commission's regulation providing an exemption from registration for
a foreign commodity pool operator trading on U.S. markets on behalf
of foreign investors.\1\ Building on previously granted staff no-
action relief, the proposal would create new possibilities for fund
managers and provide for simplified compliance. At the same time,
the proposal ensures that the Commodity Exchange Act continues to
protect U.S. market participants. Like the Commission's proposal
from January addressing its jurisdiction over foreign swap dealing
activities,\2\ this rulemaking sensibly marks the boundaries of the
Commission's reach into foreign derivatives trading activities in
light of market realities. And like the proposal from earlier this
year amending the Commission's regulations governing commodity
broker bankruptcies,\3\ in this rulemaking the Commission staff
applies their experience to make the Commission's regulations more
efficient.
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\1\ CFTC regulation 3.10(c)(3) (17 CFR 3.10(c)(3)).
\2\ Cross-Border Application of the Registration Thresholds and
Certain Requirements Applicable to Swap Dealers and Major Swap
Participants (Notice of Proposed Rulemaking), 85 FR 952 (Jan. 8,
2020).
\3\ Bankruptcy Regulations (Notice of Proposed Rulemaking)
issued by the Commission on Apr. 14, 2020, publication in the
Federal Register pending.
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I would like to highlight certain aspects of the proposal. It
would permit a foreign fund manager to satisfy the exemption's
requirement that its pool does not contain funds of U.S. investors
by complying with certain safe harbors, such as fund documentation
disclosures.\4\ The proposal recognizes that the manner in which
fund interests are sold in the real world often makes it impossible
for a fund manager to make a blanket attestation that there is no
U.S. investment in a given commodity pool. I am also particularly
pleased to see that U.S. affiliates of foreign pools would have the
ability to contribute initial capital to those pools.\5\
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\4\ Proposed regulation 3.10(c)(3)(iv).
\5\ Proposed regulation 3.10(c)(3)(iii).
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I applaud the staff of the Commission for continuing their work
despite the COVID-19 pandemic and I look forward to reviewing the
industry's comments.
Appendix 4--Statement of Commissioner Rostin Behnam
I will support today's notice of proposed rulemaking and
reopening of a comment period primarily aimed at amending the
conditions of the current exemption under Commission regulation
3.10(c)(3) (referred to as the ``3.10 Exemption'') available to
certain non-U.S. commodity pool operators (CPOs) to further reflect
the increasingly global nature of the CPO space and clarify the
Commission's approach with respect to its oversight of foreign
intermediaries that are not engaged in commodity interest activities
on behalf of U.S. customers. I greatly appreciate the time and
consideration that the staff of the Division of Swap Dealer and
Intermediary Oversight (DSIO) gave to my comments and concerns. I
also wish to thank the Office of General Counsel (OGC) staff for
ensuring that we consistently adhere to the letter and spirit of the
Commodity Exchange Act (CEA or the ``Act'') and regulations. I am
pleased that the ongoing dialog that has become a hallmark of many
working relationships within the Commission is enduring better than
ever through the pandemic, and that we can advance important policy
and regulatory initiatives without sacrificing constructive debate
and deliberation.
Today's proposal both expands the availability of the 3.10
Exemption to non-U.S. CPOs who operate both qualifying offshore
commodity pools and other commodity pools that may or may not meet
an alternative regulatory registration exemption or exclusion and
eases certain identifiable and unduly restrictive impediments to
relying on the 3.10 Exemption. Like several recent rulemakings
undertaken with respect to Part 4 of the Commission Regulations,
today's proposal is a continuation of the Commission's ongoing
efforts in honing its regulatory footprint with respect to this
dynamic segment of the derivatives market by refining our approach
through calibrating decades of policy and rulemakings to the needs
of the market participants, consumers, and the national public
interest we are charged with protecting.
Though today's proposal is brief in its delivery, it reflects
many years of staff experience and familiarity with the Commission's
historical positions and reasoning in addressing material policy
issues raised by appropriately balancing the financial interests of
foreign intermediaries and their customers with our commitment to
the financial integrity of U.S. markets and U.S. customer
protection. I believe today's proposal equally reflects the
Commission's commitment to making targeted changes in step with
improvements in surveillance and monitoring capabilities as well
with our
[[Page 35834]]
relationships with both the National Futures Association (NFA) and
foreign regulators.
Last fall, when the Commission finalized several amendments to
part 4 of the regulations addressing various registration and
compliance requirements for CPOs and commodity trading advisors, I
commended its decision to not move forward at that time on proposals
to exempt from registration qualifying CPOs operating commodity
pools outside of the U.S. consistent with Commission Staff Advisory
18-96 \1\ and adding a prohibition against statutory
disqualifications for certain exempt CPOs.\2\ The decision not to
act reflected a thoughtful consideration of the comments received
and the practicalities of both proposals as they related to ongoing
concerns about cross-border issues and the Commission's regulatory
goals.
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\1\ Advisory No. 18-96, Offshore Commodity Pools Relief for
Certain Registered CPOs from rules 4.21, 4.22 and 4.23(a)(10) and
(a)(11) and From the Location of Books and Records Requirement of
Rule 4.23 (Apr. 11, 1996), https://www.cftc.gov/sites/default/files/tm/advisory18-96.htm.
\2\ Rostin Behnam, Statement of Concurrence by CFTC Commissioner
Rostin Behnam: Amendments to Registration and Compliance
Requirements for Commodity Pool Operators and Commodity Trading
Advisors, Nov. 25, 2019, https://www.cftc.gov/PressRoom/SpeechesTestimony/behnamstatement112519.
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Today's proposal results from ongoing review and discussions
with market participants and the NFA to determine how best to
provide relief that better aligns the Commission's customer
protection concerns with the Commission's regulatory provisions in
an increasingly international asset management space.\3\ Other
aspects of today's proposal include the addition of a safe harbor
for person's engaged in CPO activities with respect to offshore
commodity pools that take certain enumerated actions aimed at
preventing U.S. persons from participating in such pools, and a
provision permitting certain U.S. control affiliates of a non-U.S.
CPO to contribute capital to such CPO's offshore pools as seed money
without impacting the non-U.S. CPO's eligibility for the 3.10(c)
Exemption. Taking a pause as opposed to rushing forward has afforded
Commission staff additional time to tailor regulatory language so as
to avoid confusion and inadvertent loss of longstanding Commission
policy aimed at protecting U.S. customers.
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\3\ Of note, today's proposal does not retract Staff-Advisory
18-96, remains available to U.S. CPOs and others who would not be in
the position to rely on the revised 3.10(c) Exemption as proposed
today.
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While I have some questions and will be interested in hearing
from commenters on the specific issues raised with regard to seed
money and certain other aspects of the proposal that seem to
permeate multiple policy-driven discussions of late, I believe
today's proposal is reasonable, will reduce regulatory burdens
without sacrificing key regulatory protections, and is drafted in
observance of the high standards for exercising exemptive authority
under section 4(c) of the Act. To that end, I am reassured that the
exercise of such authority unequivocally preserves the Commission's
authority outlined in section 4(d) of the Act to investigate a CPO's
compliance with the requirements and conditions of the 3.10(c)
Exemption, as proposed, and to bring an enforcement action for any
violation of any provision of the CEA or Commission regulations
caused by the failure to comply with or satisfy any of the
Exemption's conditions or requirements.\4\ This is in addition to
the Commission's retained authority to take enforcement action
against any non-U.S. CPO claiming the 3.10 Exemption based on their
activities within the U.S. derivatives markets consistent with our
authority regarding market participants generally.
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\4\ 7 U.S.C. 6(d).
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Again, I would like to thank the staffs of DSIO, OGC and the
rest of the Commissioners who worked to put forth this proposal.
Appendix 5--Statement of Commissioner Dan M. Berkovitz
I support the proposal to amend regulation 3.10(c)(3) addressing
the exemption from registration for foreign persons who operate
commodity pools for customers located outside of the United States
(``Proposal''). The Commission should focus its limited resources on
commodity pools in which U.S. persons participate, rather than
commodity pools located outside the U.S. in which only non-U.S.
persons participate. The Proposal addresses several specific
scenarios in which the registration exemption would apply, and which
previously created potential uncertainty for market participants.
I am concerned, however, that the provision in the Proposal that
would enable controlling affiliates--U.S. entities with U.S.
investors that provide capital to non-U.S. pools--to rely on the
exemption could be used by CPOs who take funds directly from U.S.
persons to evade the CPO registration and regulatory requirements. I
look forward to reviewing comments on whether that provision is
appropriate and whether additional conditions or limitations should
apply to prevent such abuse.
Non-U.S. Pools With no U.S. Customers
It is longstanding CFTC policy that an entity that meets the CPO
definition and trades commodity interests in our markets is not
required to register as a CPO if the entity is located offshore and
only operates pools for persons located outside of the United
States.\1\ In 2007, the Commission expressly codified the exemption
in regulation 3.10(c)(3). Customer protection is a primary goal of
the Commission's registration and regulatory requirements for
CPOs.\2\ The rationale for the exemption for foreign pools has been
that the CFTC's customer protection regulations generally should
focus on regulating activities that have an impact on U.S. customers
and commerce.\3\ To the extent the commodity pools that would be
exempt from registration under the Proposal trade derivatives on
U.S. exchanges, those activities are subject to oversight by the
exchanges and through the Commission's exchange regulations.
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\1\ See CFTC Staff Interpretative Letter 76-21 (Aug. 15, 1976).
\2\ The regulation of CPOs also facilitates the Commission's
oversight of the derivative markets, management of systemic risks,
and mandate to ensure safe trading practices. See, e.g., Commodity
Pool Operators and Commodity Trading Advisors: Compliance
Obligations, 77 FR 11252, 11253, 11275 (Feb. 24, 2012); upheld in
Investment Company Institute v. CFTC, 720 F.3d 370 (D.C. Cir. 2013).
\3\ See e.g., Commodity Exchange Act (``CEA'') section 2(i). In
contrast to this focus on customers, a primary policy goal of swap
dealer regulation is preventing systemic risk. This goal
necessitates oversight of swap trading activity outside of the
United States that can have a significant impact on U.S. commerce if
risks from that activity come back into the U.S. financial system
through regulated swap dealers. See generally Interpretive Guidance
and Policy Statement Regarding Compliance with Certain Swap
Regulations, 78 FR 45292 (July 26, 2013).
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Since the adoption of the regulation 3.10(c)(3) registration
exemption, two developments have increased the need for greater
clarity in the rule. First, changes to CFTC regulations since the
2008 financial crisis, particularly adding swap regulation and
placing needed limits on other CPO registration exemptions, have led
to a significant increase in the number of pool operators that are
technically subject to registration. Second, the business of
commodity investment management has become more global in nature,
increasing the complexity of cross border activities by the firms
that operate commodity pools.
The Proposal would exempt non-U.S. CPOs from registration and
regulation with respect to individual commodity pools that do not
solicit from U.S. persons or have U.S. investors.\4\ The Proposal
also provides that this exemption for some pools may be used with
other exemptions or exclusions permitted under our regulations.
These changes largely reflect the pre-existing policy that non-U.S.
CPOs need not register their offshore pools.
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\4\ The CPO would need to register and comply with CFTC
regulations with regard to any other commodity pools it operates
that do solicit funds from U.S. persons.
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The Proposal would provide a safe harbor to the non-U.S. CPOs in
the event that U.S. persons become inadvertently invested in the
offshore pools. The Proposal appears to provide adequate conditions
on the safe harbor to prevent abuse thereof. I look forward to
comments on whether the proposed conditions should be expanded,
reduced, or otherwise modified.
Finally, the Proposal would permit a non-U.S. CPO to rely on the
exemption even if a U.S. entity that controls the non-U.S. CPO
contributes capital in the initial funding of the exempt offshore
pools. This provision could be beneficial for U.S. fund managers
seeking to compete in foreign markets and may be acceptable with
appropriate limits.
I am concerned, however, that the controlling affiliate
provision would enable persons in the U.S. to indirectly invest--
either knowingly or unknowingly--in unregulated foreign commodity
pools. Under this provision, partnerships and corporations could
take in investment funds from U.S. persons and invest those funds in
commodity pools operated by non-U.S. pool operators that they
``control.'' Neither the controlling
[[Page 35835]]
affiliates nor the pool operators would be regulated by the CFTC.
The U.S. investors in the U.S. control affiliate would receive none
of the CPO disclosures or other protections afforded by our laws and
regulations. In fact, they may never know that the entity they are
investing in is placing their funds in offshore commodity pools.
There is no requirement to disclose this information to U.S. persons
investing in the controlling affiliate.
Furthermore, the Proposal permits an unregistered non-U.S. CPO
to accept ``initial capital contributions'' from a control affiliate
that is a U.S. person, but does not provide any limitations on the
duration or extent of such contributions. Arguably, under the
proposed provision, the controlling affiliate could fund the entire
pool investment with funds from U.S. persons and leave that amount
in the pool with no time limitation, thus allowing a complete end-
run around our CPO regulations.
The Proposal expressly acknowledges that evasion of our CPO
rules is possible and says that such evasion would be unlawful. I
want to thank the CFTC staff who drafted the Proposal for working
with my office to add some conditions to the provision. However, I
am still concerned there may be insufficient safeguards to prevent
abuse. For these reasons, I requested that several questions be
added to the Proposal to address which additional conditions could
appropriately be added to achieve the purpose of the provision and
still provide sufficient protections to the U.S. investors in the
controlling affiliate. I look forward to the comments on this issue.
Exercising Commodity Exchange Act Section 4(c) Authority
Finally, the Proposal relies on authority provided to the
Commission in CEA section 4(c) to adopt exemptions from regulatory
requirements if certain public policy goals are better served and if
certain conditions are satisfied. Generally, I am not in favor of
using this authority unless no other direct legal authority exists
and doing so clearly falls within the intent of Congress in giving
the Commission that power. During the development of the draft
Proposal, I raised a number of concerns regarding the use of section
4(c) and I want to commend the CFTC staff for their efforts to
address my concerns by more fully explaining in the Proposal why the
use of section 4(c) authority is appropriate in this instance.
[FR Doc. 2020-12034 Filed 6-11-20; 8:45 am]
BILLING CODE 6351-01-P
