Monday, December 17, 2012

CFTC Amendment to Rule 4.5 Survives Challenge

By Tim Dulaney, PhD

Last Thursday, a Federal judge ruled on a challenge to the CFTC's February 2012 amendment to Rule 4.5 (PDF) that will require mutual funds and ETFs that have sufficient non-hedging participation in derivative markets to register with the CFTC as commodity pool operators (CPOs).  The CFTC defines a CPO as a "person engaged in a business similar to an investment trust or a syndicate and who solicits or accepts funds, securities, or property for the purpose of trading commodity futures contracts or commodity options."

This decision is the result of a legal challenge to the newly adopted rule change filed by the US Chamber of Commerce and the Investment Company Institute in April of this year.  The President of ICI stated that the amendment "will impose significant compliance costs on mutual fund advisers and, ultimately, these costs will come out of shareholders’ pockets."  The challenge claimed that the CFTC registration was unnecessary given that the funds already must register with the SEC and that the amendment "violate[s] the Administrative Procedure Act as well as the Commodity Exchange Act."

The CFTC defended the amendment in June stating that an "agency need not refrain from action where data is unavailable or incomplete" and, in July, the business groups shot back claiming that the CFTC is "painting with a broad brush."  On Wednesday, the US District Court in DC tossed the suit stating that "the CFTC considered the relevant factors, acted well within its discretion, and that there was nothing arbitrary or capricious about the CFTC’s actions in promulgating the final rule."

Under the rule, fund advisers will have to register with the CFTC as CPOs or satisfy the de minimis threshold requirements (PDF) on their trading.  The threshold requirement limits either the aggregate initial margin or the aggregate notional value of derivative positions (swaps, options and futures) for non-bona fide hedging trades. 

It is unclear whether this new regulatory hurdle will benefit investors through more stable financial markets or harm them through the increased cost of regulatory compliance.  We'll continue to follow this issue as funds contend with this new rule.

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