The Wall Street Journal recently ran an article that focused on whether commodity pool operator registration is required for certain charities that use derivatives as part of their investment and risk management programs (see Is Your Charity a Commodities Trader?, available here – subscription required). This posting looks at the potential issue and the actual solution raised by the WSJ article.
WHAT IS THE POTENTIAL ISSUE?
The issue arises by virtue of the potentially broad and sometimes amorphous historical interpretation of what constitutes a “commodity pool” and, by extension, a regulated “commodity pool operator” (CPO). In sum, a commodity pool is an enterprise in the nature of an investment syndicate that uses CFTC-regulated derivatives(for example, S&P 500 futures contracts, Treasury futures, or interest rate swaps) in connection with its investment mandate. The CPO is the party (another entity or a governing body) that has ultimate oversight responsibility for the enterprise (so, for example, the charity’s board of diretors).
In the non-profit context, commodity pool status (and, by extension, CPO registration) becomes a potential issue when multiple charities combine their assets into a common investment program that uses derivatives at the level of that pooled entity or, alternately, invests in other investment funds that uses derivatives (i.e., indrect exposure to derivatives).
As background, in the context of investment funds (such as mutual funds or hedge funds), the CFTC has taken the view that a direct investment in CFTC-regulated derivatives is not required – in other words, indirect exposure obtained by virtue of a fund’s investment in another investment fund that invests in derivatives is sufficient to require the investing fund to give consideration to the issue of whether or not its operator needs to be registered as a CPO or, alternately, qualifies for an exemption from CPO registration. One item worth noting is that the guidance from the CFTC that relates to direct vs. indirect exposure to derivatives by investment funds – and the implication on CPO status – is slated to be updated, but to our knowledge has not yet been updated.
WHAT IS AN ACTUAL SOLUTION TO THE POTENTIAL ISSUE?
As alluded to near the end of the WSJ article, one solution would be for the non-profit community to request the staff of the CFTC to issue relief that outlines the conditions under which a charity would not be treated as a commodity pool. (As unimaginative as it sounds, these interpretations are often called “Not-A-Pool” letters and have been issued to a variety of commercial enterprises, ranging from securitization vehicles to churches.)
The manner in which such relief is characterized by the CFTC determines whether it can be relied upon by third parties under substantially similar fact patterns. Presumably, the CFTC has not issued guidance to other non-profits in the past in such a way so as to resolve the issue for all charities – certainly, no such guidance has been issued since the 2010 Congressional re-write of the Commodity Exchange Act and related Dodd-Frank regulatory reforms.
However, since relief has been provided to securitization vehicles as recently as last year, it would seem that relief for charities is one actual solution to the potential issue.
Good day. Good to keep that CPO thing in mind all the time. DR2