Swaps Regulation Under Dodd-Frank: Key Issues For Fund Sponsors And Advisers

Investment Management +Broker-Dealer

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act provides a detailed framework for regulating the swaps market and market participants. Dodd-Frank is radically changing how private and registered funds trade broad categories of instruments. The requirements discussed in this Alert will fall into place over the next several months, even allowing for continuing temporary relief from compliance with some swaps-related provisions of the Commodity Exchange Act, as amended by Dodd-Frank (the "CEA"). These requirements are being triggered because the rules further defining the term "swap" came into effect on October 12, 2012.

The provisions that we discuss in this Alert address, in summary, entity registration requirements that are affected by the swap definition, as well as clearing, trading, reporting, recordkeeping, margin, and business conduct requirements. This Alert focuses on these issues from the perspective of fund sponsors and advisers. These requirements may apply even if a fund sponsor or adviser is not required to register with the CFTC in any capacity.

1. CPO and CTA Registration

   As explained in our earlier Alerts from February and March 2012 in this area, the CFTC has rescinded a widely-used exemption from registration as a commodity pool operator ("CPO"), i.e., § 4.13(a)(4) of its regulations. The CFTC has also narrowed the exclusion from CPO registration in § 4.5 applicable to U.S. registered investment companies by imposing certain portfolio tests; this action is currently being challenged in federal court. These changes will take effect at the end of the year for firms that are currently able to rely on § 4.13(a)(4) and § 4.5.

   Absent another available exemption or exclusion from the CPO definition, the sponsors of funds that are considered "commodity pools" will become subject to CFTC registration, recordkeeping, and reporting requirements. (Broadly speaking, a "commodity pool" is a trust or other investment vehicle that is operated to trade commodity interests, including swaps.)

   As a result, many private fund sponsors are evaluating whether they can rely on the exemption from CPO registration provided by § 4.13(a)(3), and sponsors of registered funds are considering whether they are able to rely on the § 4.5 exclusion from CPO status. Each of these provisions requires a fund to limit its "commodity interest" positions below certain specified thresholds. For these purposes, the term "commodity interest" includes all instruments that are subject to the CFTC's jurisdiction under the CEA, including commodity futures and options, certain foreign exchange products, security futures products, and swaps.

   In considering their ability to rely on these narrower provisions, fund sponsors will have to consider a greatly expanded universe of instruments. In this regard, fund sponsors may find it helpful to consider recently-finalized rules and interpretations further defining "swap" and "security-based swap" for Dodd-Frank purposes. While "swaps" will count under § 4.13(a)(3) and § 4.5, "security-based swaps" will not. However, products that share attributes of both instrument categories may be considered "mixed swaps," which would count.

   Related questions may also arise for investment managers or sub-advisers of funds that are commodity pools. Many of these firms have relied on an exemption from registration as a commodity trading advisor ("CTA") available to firms that advise pools operated by CPOs exempt from registration with the CFTC.1 These advisers may need to consider whether any advice related to swaps, in addition to any advice regarding...