In CFTC Letter 17-48, the Division of Swap Dealer and Intermediary Oversight (the “Division”) of the Commodity Futures Trading Commission (the “CFTC”) indicated that it would not recommend enforcement action against the manager of a oil and gas fund and its subsidiaries for failure to register as a commodity pool operator (“CPO”) or a commodity trading advisor (“CTA”).  As background, the manager intended to use over-the-counter swap transactions (“Swaps”) to hedge commodity price risks relating to oil and natural gas investments made by the fund and its subsidiaries (collectively, the “Fund”).  The following are the key facts presented in CFTC Letter 17-48:

  • The Fund owns working interests, mineral interests, and overriding royalty interests in crude oil and natural gas producing and non-producing properties in Montana, North Dakota, and Oklahoma.
  • The Fund enters into Swaps in an attempt to hedge its exposure to commodity price risk as a result of the acquisition of the crude oil and natural gas interests.
  • The Swaps would constitute “bona fide hedging positions,” as that term is used in a rule proposed by the CFTC to establish position limits that apply to certain physical commodity derivatives.
  • The notional value of the Swaps corresponds with a specified percentage of proved producing reserves. The Swaps are intended to reduce the risk posed to the Fund by fluctuations in crude oil and natural gas pricing.
  • The Fund does not intend to “trade in and out” of the swaps to generate profits or mitigate losses.  The Swaps will not be used to generate investment income.
  • As a result of its use of the Swaps, the only “new” risk to which the Fund is exposed is the risk that the counterparties to the swaps will not perform their obligations in respect of the Swaps (i.e., counterparty credit risk).
  • The only commodity trading advisory activities of the Fund’s manager are its activities in respect of the Swaps.
  • The Fund and its manager will implement risk management policies and procedures reasonably designed to ensure compliance with the terms and conditions of CFTC Letter 17-48.

On the basis of these facts, the Division granted no-action relief allowing the Fund’s manager to avoid registration as a CPO/CTA, subject to the satisfaction of the following six conditions:

  1. Risk Reduction Effect – The overall riskiness of the Fund’s investments will be lower as a result of the use of the Swaps;
  2. No Speculation or Trading – The Swaps cannot be established, held, altered or terminated for the purposes of  speculation or trading;
  3. Hedging of Physical Risks Only – The Swaps can only be used to hedge commodity price risk of the Fund’s physical assets, and not the risks arising from the arrangement by which the Fund’s assets are held or financed;
  4. Counterparty Risk Only – The only “new” risk introduced to the Fund through the use of the Swaps is counterparty credit risk;
  5. Market Standard Terms – The terms and conditions of the Swaps will be consistent with generally available market terms; and
  6. Implementation of Risk Management Policies and Procedures – The Fund (including its subsidiaries) and its manager will employ risk management policies and procedures reasonably designed to ensure compliance with the terms and conditions of CFTC Letter 17-48.  These policies and procedures will include periodic testing to confirm on-going compliance with the letter with respect to any amendments to the Swaps or the structure of the Fund.

CFTC Letter No. 17-48 is available here.

Good day.  Good relief.  DR2