Investment Management Update

July 2014

Proposed Exemption from Commodity Pool Operator Status for Certain Advisers to Registered Investment Companies

Overview required to register due to the recent changes to CFTC Rule 4.5.3 While harmonized regulations eased certain On June 24, 2014, the U.S. House of Representatives adopted disclosure, reporting and recordkeeping requirements for the Commodity Futures Trading Commission Reauthorization “dually registered entities” (i.e., a RIC and its CPO), the Bill (H.R. 4413), which includes amendments sponsored by burdens remain significant. Rep. Scott Garrett (R-NJ) (Garrett Amendment).1 The Garrett Amendment proposes to exclude from the definitions of Rationale & Public Policy Reasons for Garrett commodity pool operator (CPO) and commodity trading Amendment Exclusions advisor (CTA) under the Commodity Exchange Act investment As a result of the changes to Rule 4.5, a significant number advisers to registered investment companies that invest in of investment advisers to mutual funds have had to register only “financial commodities,” e.g., S&P 500 swaps and other with the CFTC as CPOs. This second layer of regulation by securities-like derivatives, and that do not invest in the CFTC has increased costs for mutual funds and their traditional commodities, such as natural resource and shareholders. In a letter4 addressed to both the Speaker of agricultural commodities. the House and the House Minority Leader, the president of Background the Investment Company Institute points out that: • Registered funds and their investment advisers are In February 2012, the Commodity Futures Trading comprehensively regulated by the SEC Commission (CFTC) adopted modifications to the exclusions • Additional regulation by the CFTC is unnecessary from the definition of CPO in Rule 4.5 under the Commodity (particularly for those funds that do not resemble 2 Exchange Act. Specifically, the CFTC amended Rule 4.5 to or compete with traditional commodity pools) narrow the exclusion from the definition of “commodity • The Garrett Amendment would reduce the pool operator” for those entities that are investment unnecessary regulation and costs created by the companies registered as such with the Securities and CFTC without undermining investor protection Exchange Commission (SEC) pursuant to the Investment • CFTC rules would continue to govern registered funds whenever they trade in traditional Company Act of 1940 (1940 Act). Consequently, certain commodity interests as the Garrett Amendment investment advisers to investment companies registered would not alter the CFTC’s existing authority over under the 1940 Act (RICs) were subject to registration as all commodity interests CPOs with the CFTC. Subsequently, in August 2013, the CFTC issued a final “harmonization” rule with respect to Generally, the rationale for the Garrett Amendment is that certain compliance obligations for CPOs of RICs that are financial derivative-focused mutual funds and their

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investment advisers are comprehensively regulated by the SEC and that further CFTC regulation is an unnecessary employees thereof were excluded from the definition of “commodity pool operator” by virtue of the RIC’s registration under the Investment burden on shareholders. Company Act of 1940. The 2012 amendment to Section 4.5 maintained this exclusion for those RICs that engage in a de minimis amount of non-bona Outlook & Guidance fide hedging commodity interest transactions. Specifically, the amendment to Section 4.5 retained this exclusion for RICs whose non-bona fide hedging commodity interest transactions require aggregate initial margin CFTC reauthorization is now with the Senate where it has and premiums that do not exceed 5 percent of the liquidation value of the been referred to the Committee on Agriculture, Nutrition, qualifying pool’s portfolio, or whose non-bona fide hedging commodity 5 interest transactions’ aggregate net notional value does not exceed 100 and Forestry. The proposed bill is subject to change and percent of the liquidation value of the pool’s portfolio. survival of the Garrett Amendment is uncertain at best. 3 http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/fe Authority for the CFTC lapsed in 2013, but it may continue deralregister081213.pdf. to operate without congressional action under so-called 4 Investment Company Institute Memorandum No. 28200 (June 19, 2014), “unauthorized appropriations” as it did from 2005 to 2008, “Re: Garrett Amendment to H.R. 4413, the Customer Protection and End User Relief Act.” when the CFTC was last re-authorized. 5 Bill Summary & Status 113th Congress (2013–2014), Re: “Customer Protection and End-User Relief Act,” http://thomas.loc.gov/cgi- FOR MORE INFORMATION bin/bdquery/z?d113:HR04413:

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1 “Customer Protection and End-User Relief Act,” H.R. 4413, amendment No. 8 printed in House Report 113-476, Bill Summary & Status, 113th Congress (2013–2014). 2 17 CFR 4.5. See 77 FR 11252 (Feb. 24, 2012); correction 77 FR 17328 (March 26, 2012). Prior to this amendment, all RICs and the principals and