Memo #
27861

NFA Requests Comment on Proposed CPO/CTA Capital Requirement and Customer Protection Measures
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[27861]

January 24, 2014

TO: ACCOUNTING/TREASURERS COMMITTEE No. 2-14
CLOSED-END INVESTMENT COMPANY COMMITTEE No. 2-14
DERIVATIVES MARKETS ADVISORY COMMITTEE No. 5-14
OPERATIONS COMMITTEE No. 3-14
SECURITIES OPERATIONS ADVISORY GROUP
TRANSFER AGENT ADVISORY COMMITTEE No. 6-14 RE: NFA REQUESTS COMMENT ON PROPOSED CPO/CTA CAPITAL REQUIREMENT AND CUSTOMER PROTECTION MEASURES

 

On January 23, the National Futures Association (“NFA”) issued a notice to members (“NTM”) requesting comment on capital requirements for commodity pool operators (“CPOs”) and commodity trading advisors (“CTAs”) and other customer protection measures. [1]  Comments on the NTM, which is summarized below, are due by April 15, 2014. 

ICI plans to submit a comment letter on the NTM, and will hold a member call on Thursday, February 20th, from 2 -3 pm ET, to obtain member input on the letter.  If you would like to participate on the call, please RSVP to Kiera Robinson at kiera.robinson@ici.org or 202/326-5818, and she will provide you with the dial-in information for the call.

CPO/CTA Capital Requirement

Currently, CPOs and CTAs are not required to maintain a minimum amount of capital.  NFA asserts that a strong argument can be made that the rationale that requires independent introducing brokers, which are prohibited from holding customer funds, to maintain minimum capital should also apply to CPOs, which have control over customer funds, and CTAs, which manage client accounts.  NFA explains that CPOs and CTAs act as fiduciaries to their pool participants and clients, respectively, and should have adequate funds to operate and ensure that they are a going concern.  NFA requests input on the following questions from CPO and CTA members regarding a possible capital requirement:

  1. Should NFA impose a minimum capital requirement on CPO Members? CTA Members? If not, why?
  2. If you do not favor a minimum capital requirement for CPOs/CTAs, please indicate what alternatives, if any, exist for ensuring that CPOs/CTAs have sufficient funds to operate as a going concern.
  3. Assuming a capital requirement is imposed on CPOs and/or CTAs, should net capital be defined as current assets minus liabilities? If not, please describe alternative calculation(s).
  4. Assuming a capital requirement is imposed on CPOs and/or CTAs, how should the amount of the requirement be determined?
    • A minimum dollar amount that applies to all CPOs/CTAs?
    • A minimum dollar amount that applies to all CPOs/CTAs based on a certain amount of funds under management with incremental increases to the minimum amount based on additional levels of funds under management?
    • A minimum dollar amount that applies to all CPOs/CTAs with incremental increases based on factors other than funds under management (please identify the other factors)?
  5. Assuming a capital requirement is imposed on CPOs and CTAs, should there be any difference in the method of determining the required amount for CPOs or CTAs? If yes, please explain the difference(s) and the reasons for the difference(s).
  6. Assuming a capital requirement is imposed on CPOs and CTAs, how often should CPOs and CTAs have to file financial reports with NFA? Additionally, should NFA require CPOs and CTAs to file certified financial reports annually with NFA?

Other Customer Protection Measures

NFA states that, over the last 18 months, it has focused significant regulatory efforts on implementing protections over customer funds held at futures commission merchants (“FCMs”), and that it is considering several customer protection measures to address risks associated with customer assets held by CPOs.

Independent Third Party Authorization for Disbursement of Pool Funds

An NFA CPO/CTA Board member has recommended that NFA adopt a rule that would require an independent third party to review and authorize a CPO’s disbursement of any pool funds.  NFA requests input on the following questions:

  1. Would you support the adoption of this type of NFA rule imposed on CPOs? If not, why?
  2. Do you currently have an independent third party review and authorize the disbursement of pool funds? If so:
    • Is this internal control in place for all disbursements? If not, please describe the circumstances under which it is required or is not required.
    • Who is the independent third party and what qualification standards does this party meet to perform this role?
    • What is the cost per year for using the independent third party?
  3. Assuming this requirement is imposed on CPOs, who should be permitted to act as the independent third party? What, if any, qualification standards should exist for these independent third parties?
  4. Assuming this requirement is imposed on CPOs, what should be the scope of the independent party's role—what should the review and approval of disbursements from pools entail?
  5. What advantages/disadvantages do you see in this practice to your business operation? To your pool participants?

NAV Valuation and Monthly or Quarterly Reporting

NFA requests input on the following questions regarding the calculation of a pool’s net asset value (“NAV”) and monthly or quarterly reporting:

  1. Are your pool's monthly or quarterly account statements prepared in-house or are they prepared by an independent third party?
  2. Would it be beneficial for a CPO to have an independent third party prepare or verify account statements at various times throughout the year concerning the value of the pool? What advantages and/or disadvantages do you see in such a practice?
  3. Would the preparation or verification of account statements by an independent third party make it more difficult for a CPO to misrepresent NAV or misappropriate funds and thus provide greater integrity to the managed funds industry? Would the benefit of having independent third party verification outweigh the added costs?

Performance Results

NFA requests input on the following questions regarding pool performance results:

  1. Are your pool's performance results prepared in house or are they prepared by an independent third party?
  2. If performance results are prepared in house, would independent verification of those results by a third party be beneficial? If not, why?
  3. Would the preparation or verification of performance results by an independent third party make it more difficult for a CPO to misrepresent NAV or misappropriate funds and thus provide greater integrity to the managed funds industry? Would the benefit of having independent third party verification outweigh the added costs?

Verification of Pool Assets

NFA currently requires depositories with accounts holding customer segregated funds for an FCM to report the balances in those accounts to NFA on a daily basis.  NFA compares the reported information to the customer segregated funds balances reported by the FCM and reconciles any material discrepancies.  It is considering a similar system for pool assets, and requests input on the following questions:

  1. Do you see any impediments to NFA developing such a system for pool assets? If yes, please describe.
  2. Do you have any suggestions on how NFA could obtain the balances from entities holding pool assets that are not banks or FCMs?
  3. If NFA is able to develop such a system, how frequently should NFA require CPOs to report pool assets and entities holding pool assets to independently report balances?

Inactive Members

Finally, NFA requests comment on whether it is appropriate for inactive CPOs and CTAs (i.e., those that do not engage in any commodity interest trading) to remain NFA members and requests input on questions related to that topic.

 

Sarah A. Bessin
Senior Counsel

Rachel H. Graham
Senior Associate Counsel

endnotes

[1] NFA Notice to Members I-14-03 (Jan. 23, 2014), available at http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4377.