CFTC Proposes Rule Amendments to Expand Exemptions for Non-U.S. Commodity Pool Operators
On May 28, 2020, the Commodity Futures Trading Commission (“CFTC”) approved proposed amendments to CFTC Regulation 3.10(c), which currently provides a jurisdictional based registration exemption for non-U.S. commodity pool operators (“CPOs”) that operate non-U.S. funds with non-U.S. investors (the “Proposed Amendments”). Historically, the CPO registration exemption available under Regulation 3.10(c)(3) has presented challenges for non-U.S. CPOs since it requires that a non-U.S. CPO must satisfy the Regulation’s requirements across all of its commodity pools rather than being available on a “pool-by-pool” basis.
The Proposed Amendments would, if adopted:
- modify the current “all or nothing” interpretation of the Regulation and allow non-U.S. CPOs to claim a Regulation 3.10(c) registration exemption on a “pool-by-pool” basis for its qualifying commodity pools while registering or relying on other exemptions or exclusions for its non-qualifying pools;
- add a new safe harbor for relying on Regulation 3.10(c) upon satisfying certain requirements; and
- permit certain U.S. controlled affiliates of a non-U.S. CPO to provide seed funding to an offshore pool and still have such pool be eligible for the Regulation 3.10(c) exemption.
The Proposed Amendments will be subject to a 60-day comment period after publication in the Federal Register. The proposed rule notice can be found here.
Proposed Safe Harbor for Unintended U.S. Investments
Currently, relying on the Regulation 3.10(c) registration exemption requires a non-U.S. CPO to certify that it is acting only for persons located outside of the U.S. (i.e., non-U.S. persons). While the language of Regulation 3.10(c) does not contain an explicit definition of a “U.S. person,” the CFTC’s longstanding no-action position on which the Regulation was based has historically required that a non-U.S. CPO, which operates pools that may trade commodities on U.S. or non-U.S. exchanges, (i) confine its pool activities to areas outside of the territorial U.S., (ii) none of its pool participants is a resident or citizen of the U.S., and (iii) none of the funds or capital contributed to the pools are from U.S. sources.1 Many participation units in pools, however, are not purchased directly from the pool, so a non-U.S. CPO may not be able to identify every ultimate beneficial owner of an offshore pool and unintended U.S. investments may occur.
To address this issue, the CFTC’s Proposed Amendments would provide a safe harbor that would allow a non-U.S. CPO to rely on Regulation 3.10(c) without definitively knowing all of its ultimate beneficial owners. To qualify for the safe harbor, a non-U.S. CPO would have to satisfy a list of five requirements that must be supported by documentation to demonstrate compliance The five requirements are intended to minimize the possibility of U.S. persons being solicited for, or sold, participation units in the offshore pool and must address the following:
- Written Prohibitions in Offering Material/Underwriting and Distribution Agreements. The offshore pool’s offering materials and any underwriting or distribution agreements must include clear, written prohibitions on the offshore pool’s offering to participants located in the U.S. and on U.S. ownership of the offshore pool’s participation units.
- Design of Offshore Pool’s Offering Materials and Constitutional Documents. The offshore pool’s constitutional documents and offering materials: (a) must be reasonably designed to preclude persons located in the U.S. from participating therein, and (b) must include mechanisms reasonably designed to enable the CPO to exclude any persons located in the U.S. who attempt to participate in the offshore pool, notwithstanding those prohibitions.
- Exclusive Use of Offshore Intermediaries. The non-U.S. CPO must exclusively use offshore intermediaries for the distribution of participations in the offshore pool.
- Reasonable Investor Due Diligence. The non-U.S. CPO must use reasonable investor due diligence methods at the time of sale to preclude persons located in the U.S. from participating in the offshore pool.
- Direction and Distribution of Participation Interests to Non-U.S. Persons. The offshore pool’s participation units must be directed and distributed to participants outside of the U.S., including by means of listing and trading such units on secondary markets organized and operated outside of the U.S., and in which the offshore CPO has reasonably determined participation by persons located in the U.S. is unlikely.
U.S. Affiliate Investment Exception
In determining whether an offshore commodity pool acts on behalf of only non-U.S. persons and therefore qualifies for the Regulation 3.10(c) registration exemption, the Proposed Amendments would not consider initial capital contributed by a U.S. controlling affiliate of the non-U.S. CPO. The Proposed Amendments 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 Regulation 3.10 exemption.
The Proposed Amendments should be a welcomed development for non-U.S. investment managers. Among other things, the Proposed Amendments provide flexibility and legal certainty to non-U.S. managers in operating their business that may have little or no connection with the U.S. The Proposed Amendments were unanimously approved by all of the CFTC commissioners, so it is expected that the CFTC will soon adopt a final rule that is substantially similar to the Proposed Amendments.
1 See CFTC Interpretive Letter No. 76-21 (Aug. 15, 1976): https://cftc.gov/sites/default/files/idc/groups/public/@lrlettergeneral/documents/letter/76-21.pdf.