The CFTC Proposes Changes to Regulation 4.7 (Registration Lite)

The Commodity Futures Trading Commission (CFTC or Commission) published a Notice of Proposed Rule Making (the Proposal) on October 2, 2023 to amend CFTC Regulation 4.7.

CFTC Regulation 4.7 sets forth requirements for commodity pool operators (CPOs) that offer commodity pools to qualified eligible persons (QEPs) and commodity trading advisors (CTAs) that provide advisory services to QEPs (generally institutional and sophisticated investors and clients that meet specific portfolio or qualification requirements). CFTC Regulation 4.7 is also known as “Registration Lite” because it exempts CPOs and CTAs serving QEPs from certain disclosure, reporting, and recordkeeping requirements. According to the CFTC Fact Sheet and Q&A, 4.7 CPOs and CTAs significantly exceed the number of fully registered CPOs and CTAs.  

The Commission is proposing significant changes to various aspects of this regulation. Of notice, is the introduction of targeted disclosure requirements for 4.7 CPOs and CTAs.

The proposed changes

The CFTC is proposing the following changes to Regulation 4.7:

1. Update the financial thresholds in the Portfolio Requirements of the QEP definition to account for the effects of inflation over the last three decades. When the CFTC adopted the QEP definition and the associated Portfolio Requirement, the Commission sought to harmonize Regulation 4.7 with the existing securities laws and regulations for sophisticated investors by incorporating the Securities and Exchange Commission’s (SEC’s) definition of “accredited investors” in the QEP definition. However, in the Proposal, the CFTC insisted that due to the differences between commodity interest products and securities investments, the QEP definition could not rely solely on the SEC’s “accredited investors” definition and should therefore maintain the Portfolio Requirement. Additionally, to account for the effects of inflation since the rule adoption in 1992, the CFTC is proposing to update the Portfolio Requirement's thresholds by doubling the Securities Portfolio Test to $4,000,000, and the Initial Margin and Premium Test to $400,000. In the Proposal, the CFTC acknowledges that the proposed new Portfolio Requirements may result in existing investors and clients not being able to meet the new thresholds. However, the CFTC is proposing to maintain CFTC Regulation 4.7(a)(3), which requires the Portfolio thresholds to be satisfied at the time of sale of participation interests in a pool or opening an exempt account. The CFTC is not proposing the mandatory redemption of investments or the termination of client accounts of QEPs that do not meet the heightened threshold. However, it is unclear if they should be required to provide evidence that they satisfy the increased threshold.

2. Establish minimum disclosure requirements under CFTC Regulation 4.7. Currently, CPOs and CTAs, that are registered pursuant to CFTC Regulation 4.7, are exempt from certain disclosure, reporting, and recordkeeping requirements, provided certain conditions are satisfied. The proposal updates the disclosure exemptions for 4.7 CPOs and CTAs by incorporating the below targeted disclosure requirements aimed at enhancing customer protection, transparency, and fairness.

   The aim of these proposed disclosures is to account for the different level of resources available to each QEP to help make investment decisions, the QEP’s diminished power to demand the same level of information about their investments that the received at the outset, the QEP’s different bargaining powers, and the increased complexity and diversity of products offered to QEPs.

   CPO Disclosures

   The Proposal removes the exemption from specific provisions of CFTC Regulations 4.24 and 4.25 and requires that CPOs provide prospective QEP investors with the following disclosures in the pool’s offering memorandum:

   • The Pool’s Principal Risk Factors – A description of risks relating to volatility, leverage, liquidity, and counterparty creditworthiness.

   • Investment Program and Use of Proceeds – A description of types of commodity interests and other interests traded by the pool, trading, and investment program, major CTAs involved in the trading program and respective allocation of pool assets, major investees in the fund, use of proceeds and how the pool will satisfy margin requirements, percentage of pool assets held in segregation, and to whom income from margin or security deposit will be paid.

   • Custodian(s) – A description of the custodian or any other entity, such as bank or broker-dealer, that will hold commodity interests and other interests the pool will be trading.

   • Fees and Expenses – A complete description of each fee, commission, and other expense that the CPO knows or should know has been incurred by the pool for its preceding fiscal year, and is expected to be incurred by the pool in its current fiscal year, including fees and other expenses incurred in connection with the pool's participation in investee pools and funds.

   • Any Actual or Potential Conflicts of Interest – A description of conflicts of interest regarding any aspect of the pool on the part of the CPO, the trading manager, any major CTA, the CPO of any major investee pool, any principal of the foregoing, any other person providing services to the pool, and any material conflicts involving the pool.

   • Certain Performance Disclosures, Including Basic Past Performance Information – The Commission is proposing to require QEP disclosures to include performance disclosures that comply with Regulation 4.25.

     CTA Disclosures

     The Proposal removes the exemption from specific provisions of CFTC Regulations 4.34 and 4.35 and requires that CTAs provide prospective QEP clients with any brochure or other disclosure statement that includes the following disclosures:

   • Identification of Certain Persons - Name of each Principal of the CTA, the futures commission merchant (FCM) and/or retail foreign exchange dealer (RFED), and any introducing broker.

   • Description of Principal Risk Factors - Risks due to volatility, leverage, liquidity, and counterparty creditworthiness.

   • Description of the 4.7 Trading Program - A description of the (a) CTA’s chosen method to offset positions at the FCMs and/or RFEDs carrying the CTA managed accounts and (b) types of commodity interests and other interests and relevant trading restrictions or limitations.

   • Fees – A description of each fee to be charged to clients, including additional details of fees, where the fees are dependent on specifically listed base amounts, or on any increase in a client's commodity interest account.

   • Conflicts of Interest - A description of (a) any actual or potential conflict of interest regarding the CTA, the FCM and/or RFED, any introducing broker, and any principal thereof, and (b) any material conflicts of interest concerning the CTA’s trading programs.

   • Past Performance of 4.7 Trading Programs - Currently, CTAs are exempt from disclosing performance information for their 4.7 trading programs. This Proposal mandates that CTA disclosures include capsule performance information for past performance of an account or trading program in accordance with Regulation 4.35.

3. Allow CPOs of Funds of Funds to distribute monthly account statements within 45 days of the month-end consistent with routinely issued CFTC exemptive letters. Generally, Fund of Funds’ CPOs are unable to control when they receive financial statements from the underlying pools. As a consequence, Fund of Funds’ CPOs request exemptive letters from the CFTC to allow them to follow account statement schedules other than the quarterly reporting schedules mandated under Regulation 4.7. The CFTC has routinely granted those requests by permitting the Fund of Fund’s CPOs to distribute monthly financial statements within 45 days after month-end. The CFTC is proposing to amend Regulation 4.7 to allow Fund of Funds’ CPOs to distribute financial statements in accordance with the routinely issued CFTC exemptive letters.
4. Other technical amendments. The Proposal also introduces several technical amendments to Regulation 4.7, such as deleting the introductory paragraph, restructuring the definitions under 4.7(a), removing unnecessary sub-paragraph levels, and more.

The CFTC is currently seeking comments about these proposed changes. Comments on the Proposal must be submitted by December 11, 2023 (60 days after the publication of the Proposal in the Federal Register) at Public Comment Form - CFTC.

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