NEW YORK (HedgeWorld.com)--The U.S. Commodity Futures Trading Commission announced a temporary exemption from registering for traders that meet certain criteria, giving hedge funds easier access to futures markets.
Some hedge fund managers have already filed for no-action relief that for now releases them from having to register as commodity pool operators and commodity trading advisers.
Moreover, the CFTC is reviewing separate proposals from the National Futures and Managed Funds associations that would permanently expand exemptions but do so on different grounds. The Commission will solicit comments on these proposals through Jan. 13, 2003.
These new rules have been in the works for years, said Mike Griffin, the head of New York-based Dorsey & Whitney's hedge fund practice. But now that the proposals are out, industry people are hoping to get new exemptions on the books before too long, once the comments come in.
The CFTC wants more people in this market, commented Robert Leonard, who leads the New York-based Bryan Cave hedge fund practice. The previous rules kept some hedge fund managers out by imposing onerous requirements even on funds that did a little futures trading. The burden was substantial, said Jeffrey Cobb of Cobb & Eisenberg, Southport, Conn. For example, principals of a firm had to take a commodities exam. "The community has been waiting for something like this for a long time," Mr. Cobb said, "That funds can get the benefit of the rule by simply filing for no action is a very positive position for the CFTC to take."
Mr. Leonard advises hedge fund operators to stay with their current status if they are already registered but to take advantage of the no-action relief if they are starting out new. Law firms have been filing for their clients to get the temporary exemption. The change may make life easier for people interested in using the new single-stock futures and other instruments.
There is a basic difference in approach between the MFA and NFA proposals. Which one will emerge as the accepted version is not yet clear. The attorneys take the fact that CFTC asked for comment on both proposals as indication that much is on the table. There could be serious tweaking of requirements on the basis of comments received.
Mr. Griffin explained that one ground for exemption is the limited amount or purpose of a fund's futures trading. But another approach is to focus on whether a fund's clients are accredited or "qualified eligible persons" as defined by Rule 4.7 of the Securities Act.
The NFA proposal releases traders from registration if they use commodity futures and options solely for bona fide hedging purposes rather than to get returns. Exemption also applies even if this is not the case as long as the trading positions do not exceed 5% of net assets. So the NFA criteria are based on the activities of a fund.
By contrast, the MFA proposes a super-accredited-investor criterion. If a fund takes money only from investors that are qualified eligible persons, it gets an exemption. Under this proposal the amount or purpose of a fund's futures trading is not the issue. Sophisticated wealthy investors arguably do not need to be protected by CPO registration.
Funds of Funds
This difference in reasons for release has implications for hedge funds of funds that invest with managers that engage in some futures trading. "The exemption should apply to fund of funds," said Mr. Griffin, "But neither the CFTC no-action relief nor the two proposals expressly address that question."
There could be any number of possibilities, depending on which proposal is adopted, he pointed out. The MFA approach has a straightforward implication for funds of funds, as it considers only investors' qualifications. In theory, if a fund of funds limits investors to the super-accredited, the exemption should apply, said Mr. Griffin.
But how the CFTC's interim relief or the NFA proposal will apply to funds of funds is a more complicated issue. Mr. Griffin reasons that there would have to be a look-through analysis or multi-level calculation of underlying funds' futures trading. This is one of the issues that await clarification.