[Federal Register Volume 67, Number 208 (Monday, October 28, 2002)]
[Proposed Rules]
[Pages 65743-65746]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-27309]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 4

RIN 3038-AB34


Exclusion for Certain Otherwise Regulated Persons From the 
Definition of the Term ``Commodity Pool Operator''

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rule.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC) 
is proposing to amend Rule 4.5 by adding an alternative limitation on 
the non-hedge activities of eligible persons claiming relief under the 
rule (Proposal). The Commission also is taking a ``no-action'' position 
to permit the use of this alternative criterion pending final action on 
an amendment to the rule. The Proposal and the ``no-action'' position 
would not affect the ability of qualifying entities under Rule 4.5 to 
engage in unlimited trading for bona fide hedging purposes.

DATES: Comments on the proposed rule change must be received by 
December 12, 2002.

ADDRESSES: Comments on the proposed rule should be sent to Jean A. 
Webb, Secretary, Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street, NW., Washington, DC 20581. Comments may be 
sent by facsimile transmission to (202) 418-5528, or by e-mail to 
[email protected]. Reference should be made to ``Proposed Amendment to 
Rule 4.5 for Non-Hedge Activity.''

FOR FURTHER INFORMATION CONTACT: Barbara S. Gold, Associate Director, 
Division of Clearing and Intermediary Oversight, or Ronald Hobson, 
Industry Economist, Office of the Chief Economist, Commodity Futures 
Trading Commission, 1155 21st Street, NW., Washington, DC 20581, 
telephone number: (202) 418-5441 or (202) 418-5285, respectively; 
facsimile number: (202) 418-5536, or (202) 418-5660, respectively; and 
electronic mail: [email protected] or [email protected], respectively.

SUPPLEMENTARY INFORMATION:

I. Background

    The term ``commodity pool operator'' (CPO) is defined in section 
1a(5) of the Commodity Exchange Act (Act),\1\ to mean:
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    \1\ 7 U.S.C. 1a(5) (2002).

    [A]ny person engaged in a business that is of the nature of an 
investment trust, syndicate, or similar form of enterprise, and who, 
in connection therewith, solicits, accepts, or receives from others, 
funds, securities, or property, either directly or through capital 
contributions, the sale of stock or other forms of securities, or 
otherwise, for the purpose of trading in any commodity for future 
delivery on or subject to the rules of any contract market or 
derivatives transaction execution facility, except that the term 
does not include such persons not within the intent of the 
definition of the term as the Commission may specify by rule, 
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regulation, or order. [Emphasis added.] \2\

    \2\ Both the Act and the Commission's rules issued thereunder 
can be accessed through the Commission's Web site: www.cftc.gov/cftc/cftclawreg.htm#cea. Commission rules cited to herein are found 
at 17 CFR chapter I (2002).
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    In connection with the adoption of the Futures Trading Act of 
1982,\3\ the Senate Committee on Agriculture, Nutrition, and Forestry 
(Committee) considered an amendment to the Act that would have exempted 
certain persons from the CPO definition. In lieu of adopting such an 
amendment to the CPO definition, the Committee directed the Commission 
to issue regulations that would have the effect of providing relief 
from regulation as a CPO for certain otherwise regulated persons with 
respect to their operation of certain collective investment vehicles 
that met certain criteria. These criteria specified, among other 
things, that ``the entity uses commodity futures or options thereon

[[Page 65744]]

solely for hedging purposes'' and that ``initial margin requirements or 
premiums for * * * futures or options contracts will never be in excess 
of 5 percent of the entity's assets. * * *'' \4\ Pursuant to this 
directive, in 1985 the Commission adopted Rule 4.5.\5\
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    \3\ Pub. L. No. 97-444, 96 Stat. 2294 et seq. (1983).
    \4\ S. Rep. No. 384, 97th Cong., 2d Sess. 79-80 (1982).
    \5\ 50 FR 15868 (Apr. 23, 1985), which contains a full 
discussion of the history of the directive and the subsequent 
adoption of Rule 4.5.
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    The purpose of Rule 4.5 is to make available to certain persons 
(eligible persons) an exclusion from the definition of CPO with respect 
to their operation of certain entities (qualifying entities) that would 
otherwise be treated as commodity pools under the Act, but that are 
already subject to extensive operating requirements of another federal 
or state regulator. These eligible persons and their qualifying 
entities include: (1) Investment companies registered as such under the 
Investment Company Act of 1940; (2) state-regulated insurance companies 
with respect to their operation of insurance company separate accounts; 
(3) state- or federally-regulated financial depository institutions 
with respect to their operation of separate units of investment; and 
(4) trustees, named fiduciaries, certain designated fiduciaries, and 
employers of pension plans subject to Title I of the Employee 
Retirement Income Security Act of 1974 with respect to the operation of 
such plans.\6\ In order to claim exclusion from the CPO definition 
under Rule 4.5, an eligible person must file a Notice of Eligibility 
with the National Futures Association (NFA) and the Commission.\7\ The 
Notice must contain specified representations on how the person will 
operate the qualifying entity. These operating criteria include 
requirements to: restrict the amount of the entity's commodity interest 
trading with respect to its non-hedging activity; not market the entity 
as a pool or otherwise as a vehicle to trade commodity interests; 
disclose the purpose of and restrictions on the entity's commodity 
interest trading; and submit to special calls to demonstrate compliance 
with the foregoing provisions. A supplemental Notice must be filed, as 
necessary, to render the original Notice ``accurate and complete.'' \8\
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    \6\ Rules 4.5(a) and (b).
    \7\ Rule 4.5(c).
    \8\ Rule 4.5(d).
    Over the past ten years, eligible persons have filed 
approximately 15,500 initial and supplemental Notices with the NFA 
and the Commission, as follows: registered investment companies 
(filing on a series-by-series basis)--12,000; state-regulated 
insurance companies--600; state- or federally-regulated financial 
depository institutions--2,700; and pension plan trustees, 
fiduciaries and employers--200. However, not all of the qualifying 
entities named in these Notices may still be in operation as of this 
date.
    Additionally, Rule 4.5 provides that certain pension plans are 
not commodity pools. Because this exclusion is self-executing, no 
notice must be filed to claim it. Accordingly, the amendment to Rule 
4.5(c) that the Commission is today proposing does not apply to 
these plans or their operation. See Rule 4.5(a)(4)(i)-(iv).
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    Based upon its staff's experience in administering Rule 4.5, the 
Commission has made various revisions to the rule subsequent to its 
initial adoption. These revisions have expanded the range of persons 
eligible to claim relief under the rule \9\ and the trading strategies 
that may be engaged in under the rule--i.e., that unlimited hedging but 
limited non-hedging activities may be engaged in under the rule.\10\ 
Based upon staff's most recent experience with Rule 4.5, the Commission 
again is proposing revisions to the rule and, in particular, to the 
operating criteria concerning the amount of a qualifying entity's non-
hedging commodity interest trading.
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    \9\ See 58 FR 43791 (Aug. 18, 1993). The Commission also has 
expanded the class of persons who are ``non-pools'' under Rule 4.5. 
See 65 FR 24127 (Apr. 25, 2000).
    \10\ See 58 FR 6371 (Jan. 28, 1993).
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II. The Proposal

A. The Text of the Proposal

    Currently, Rule 4.5(c)(2)(i) provides that the Notice of 
Eligibility must contain a representation that the eligible person must 
operate the qualifying entity such that the entity:

    Will use commodity futures or commodity option contracts solely 
for bona fide hedging purposes within the meaning and intent of 
[Rule] 1.3(z)(1); Provided, however, That in addition, with respect 
to positions in commodity futures or commodity option contracts 
which do not come within the meaning and intent of [Rule] 1.3(z)(1), 
a qualifying entity may represent that the aggregate initial margin 
and premiums required to establish such positions will not exceed 
five percent of the liquidation value of the qualifying entity's 
portfolio, after taking into account unrealized profits and 
unrealized losses on any such contracts it has entered into; And, 
Provided further, That in the case of an option that is in-the-money 
at the time of purchase, the in-the-money amount as defined in 
[Rule] 190.01(x) may be excluded in computing such 5 percent.

    This limitation on non-hedge activity contained in Rule 4.5 has 
come to be known as ``the 5 percent test.''
    Because futures margins have generally been set at levels near or 
below 5 percent of contract value, the 5 percent test has permitted the 
notional value of non-hedging commodity futures and option positions to 
approximate the liquidation value of an entity's portfolio. Recently, 
however, eligible persons and qualifying entities have expressed 
concern to Commission staff over the 5 percent test, because margin 
levels for certain stock index futures have come to significantly 
exceed 5 percent of contract value, thereby limiting the use of such 
contracts in non-hedging strategies to a much greater extent than other 
types of contracts with lower margins.\11\ They also have expressed 
concern that a similar constraint could arise with respect to security 
futures products (SFPs), because the required margin for SFPs will be 
20 percent of contract value.\12\
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    \11\ See, e.g., comments received in connection with the 
Commission's Roundtable on CPO and CTA Issues, held on September 19, 
2002. These comments may be accessed at http://www.cftc.gov/opa/press02/opa4700-02.htm.
    The Commission held the Roundtable as a result of its ``Report 
on the Study of the Commodity Exchange Act and the Commission's 
Rules and Orders Governing the Conduct of Registrants Under the 
Act.'' The Report was mandated by section 125 of the Commodity 
Futures Modernization Act of 2000 (CFMA), which directed the 
Commission to conduct a study of those sections of the Act and the 
Commission's rules applicable to intermediaries. The Report can be 
accessed through: www.cftc.gov/files/opa/opaintermediarystudy.pdf, 
and section 125 of the CFMA can be accessed through: www.cftc.gov/files/ogc/ogchr5660.pdf.
    \12\ See CFTC Rule 41.45(b)(1) and Securities and Exchange 
Commission Rule 403(b)(1), 67 FR 53146, 53174 and 53179, 
respectively (Aug. 14, 2002).
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    In response to these concerns, the Commission is proposing to amend 
Rule 4.5 by adding as an alternative to the 5 percent test a limitation 
based on the notional value of non-hedge positions. This amendment 
would reorganize paragraph (c)(2)(i) of the rule, to: (1) Redesignate 
the 5 percent test as new paragraph (c)(2)(i)(A); and (2) provide an 
alternative non-hedge operating criterion in new paragraph 
(c)(2)(i)(B).
    As proposed, this alternative would provide that, with respect to 
non-hedge commodity interest positions, a qualifying entity may 
represent that the aggregate notional value of such positions does not 
exceed the liquidation value of the qualifying entity's portfolio 
(notional test). This alternative is based upon a proposal recently 
made to the Commission's Division of Clearing and Intermediary 
Oversight in connection with a request for ``no-action'' relief from 
the 5 percent test of Rule 4.5(c)(2).\13\ For the purpose of the 
notional test, ``notional value'' would be calculated for futures by 
multiplying for each such position the size of the contract, in 
contract units, by the current market price per unit and for

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options by multiplying for each such position the size of the contract, 
in contract units, by the strike price per unit.
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    \13\ See Letter of Barclays Global Investors, N.A. dated July 
18, 2002, to Jane K. Thorpe, Director of the Division.
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    The following two examples show the different effects of the 
existing and proposed non-hedging tests using futures contracts based 
on equity, in one instance, and on debt, in the other instance. In each 
example, the eligible person desires to establish the maximum number of 
contracts permissible for the qualifying entity. In both examples, it 
is assumed that the entity's liquidation value is $10 million, the 
settlement level of the contract is as of September 25, 2002, and the 
margin requirement is as of September 26, 2002.
    With respect to the S&P 500 Stock Price Index futures contract 
traded on the Chicago Mercantile Exchange, the number of contracts the 
person could establish would be:

5% of liquidation value = $500,000 (.05 x $10,000,000)
Initial non-hedge margin for a single S&P contract = $17,813, or almost 
9% of contract value
S&P settlement level = 819.29 points
S&P contract value = $204,822.50 (819.29 x $250 per point)
5% Test = 28 contracts ($500,000/$17,813=28.07)
Notional Test = 48 contracts ($10,000,000/$204,822.50=48.8)

    Thus, for establishing positions in the S&P 500 Stock Price Index 
future contract, the notional test would be less restrictive.
    With respect to the 10-Year Treasury Note contract traded on the 
Chicago Board of Trade, the number of contracts that the eligible 
person could establish would be:

5% of liquidation value = $500,000 (.05 x $10,000,000)
Initial non-hedge margin for a single T-Note contract = $1,755, or less 
than 2% of contract value
T-Note settlement level = 114,160 points
T-Note contract value = $114,160 (114,160 x 100%)
5% Test = 284 contracts ($500,000/$1,755=284.9)
Notional Test = 87 contracts ($10,000,000/$114,160=87.6)

    Thus, for establishing positions in the 10-Year Treasury Note 
contract, the 5 percent test would be less restrictive.
    The following table summarizes this information:

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                                                                        Initial      Settlement                                     No.       Contracts
                 Contract                   Liquidation       5%       margin (as  level (as of 9/  Multiplier  Contract value   Contracts     notional
                                               value                  of 9/26/02)      25/02)                                     5% test        test
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S&P.......................................         $10m     $500,000      $17,813          819.29         $250     $204,822.50           28           48
T-Note....................................          10m      500,000        1,755      114,160.00         100%      114,160.00          284           87
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    The Proposal (and the ``no-action'' position taken below) would not 
affect the ability of eligible persons claiming relief under Rule 4.5 
to use commodity interests for bona fide hedging purposes on an 
unlimited basis. Rather, it would establish a second, alternative test 
under which they could use commodity interests for other than bona fide 
hedging purposes. Also, the Proposal (and the ``no-action'' position) 
would not affect any other provision of Rule 4.5, including the proviso 
following paragraph (c)(2) of the rule that:

the making of such representations [as are required in the Notice of 
Eligibility] shall not be deemed a substitute for compliance with 
any criteria applicable to commodity futures or commodity options 
trading established by any regulator to which [an eligible] person 
or qualifying entity is subject.

B. Request for Comment

    The Commission requests comment on the Proposal and on the 
following issues:
    (1) Do the proposed changes adequately address perceived problems 
with the existing requirements under Rule 4.5?
    (2) Is there some other limitation for non-hedge positions that the 
Commission should adopt in lieu of, or in addition to, the existing and 
proposed limitations?
    (3) Should the Commission impose any limitation for non-hedge 
activity by persons claiming relief under Rule 4.5?

C. ``No-Action'' Position

    The Proposal would facilitate the use of the commodity interest 
markets by persons and entities who, in accordance with Rule 4.5, are 
``otherwise regulated'' and it would potentially benefit other market 
participants through increased liquidity. Accordingly, the Commission 
has determined that, pending action on the Proposal, it will not 
commence any enforcement action against an eligible person for failing 
to register as a CPO in accordance with section 4m(1) of the Act,\14\ 
where the eligible person operates a qualifying entity in accordance 
with the proposed revisions to Rule 4.5(c)(2).
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    \14\ 7 U.S.C. 6m(1).
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    Neither eligible persons who have claimed relief under Rule 4.5 nor 
eligible persons who claim such relief in the future need to take any 
additional action to operate their qualifying entities in accordance 
with the notional test. Rather, making the representations currently 
required by the rule in a Notice filed with the NFA and the 
Commission--including the representation concerning the 5 percent 
test--is all that is required.
    This position will remain in effect until such time as the 
Commission takes final action on the Proposal. It is, however, subject 
to the condition that upon adoption of any amendment to Rule 4.5, the 
eligible person must comply in full with the terms of any amendment as 
the Commission may adopt or with the existing 5 percent test of Rule 
4.5. In the event the Commission adopts an alternative non-hedge 
operating criterion that varies from the criterion proposed herein, it 
will provide affected eligible persons and qualifying entities with 
sufficient time within which to comply with the criterion as adopted.

III. Related Matters

A. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (PRA),\15\ which imposes 
certain requirements on Federal agencies (including the Commission) in 
connection with their conducting or sponsoring any collection of 
information as defined by the PRA, does not apply to the Proposal. The 
Commission believes the proposed amendment of Rule 4.5 does not contain 
information requirements which necessitate the approval of the Office 
of Management and Budget, because the purpose of the amendment is to 
provide an alternative representation that may be made to claim the 
relief available under the rule.
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    \15\ 44 U.S.C. 3501 et seq.
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B. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) \16\ requires that agencies, 
in promulgating rules, consider the impact

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of these rules on small entities. The definitions of small entities 
that the Commission has established for this purpose do not address the 
eligible persons and qualifying entities set forth in Rule 4.5 because, 
by the very nature of the rule, the operations and activities of such 
persons and entities generally are regulated by federal and state 
authorities other than the Commission. Assuming, arguendo, that such 
persons and entities would be small entities for purposes of the RFA, 
the Commission believes that the Proposal would not have a significant 
economic impact on them because it would relieve a greater number of 
those persons (and entities) from the requirement to register as a CPO 
and from the disclosure, reporting and recordkeeping requirements 
applicable to registered CPOs.
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    \16\ 5 U.S.C. 601 et seq.
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    Accordingly, the Chairman, on behalf of the Commission, certifies 
pursuant to section 3(a) of the RFA,\17\ that the Proposal will not 
have a significant economic impact on a substantial number of small 
entities. Nonetheless, the Commission invites comment from any person 
who believes that these rules, as proposed, would have a significant 
economic impact on its operation.
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    \17\ 5 U.S.C. 605(b).
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List of Subjects in 17 CFR Part 4

    Commodity pool operators, Commodity trading advisors, Commodity 
futures, Commodity options.

    Accordingly, 17 CFR chapter I is proposed to be amended as follows:

PART 4--COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS

    1. The authority citation for part 4 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 6b, 6c, 6(c), 6l, 6m, 6n, 6o, 12a, 
and 23.

Subpart A--General Provisions, Definitions and Exemptions

    2. Section 4.5 is proposed to be amended by revising paragraph 
(c)(2)(i) to read as follows:


Sec.  4.5  Exclusion for certain otherwise regulated persons from the 
definition of the term ``commodity pool operator.''

* * * * *
    (c) * * *
    (2) * * *
    (i) Will use commodity futures or commodity options contracts 
solely for bona fide hedging purposes within the meaning and intent of 
Sec.  1.3(z)(1) of this chapter; Provided, however, That in addition, 
with respect to positions in commodity futures or commodity option 
contracts which do not come within the meaning and intent of Sec.  
1.3(z)(1), a qualifying entity may represent that:
    (A) The aggregate initial margin and premiums required to establish 
such positions will not exceed five percent of the liquidation value of 
the qualifying entity's portfolio, after taking into account unrealized 
profits and unrealized losses on any such contracts it has entered 
into; Provided further, That in the case of an option that is in-the-
money at the time of purchase, the in-the-money amount as defined in 
Sec.  190.01(x) of this chapter may be excluded in computing such five 
percent; or
    (B) The aggregate notional value of such positions does not exceed 
the liquidation value of the qualifying entity's portfolio, after 
taking into account unrealized profits and unrealized losses on any 
such contracts it has entered into. For the purpose of this paragraph 
(c)(2)(i)(B), the term ``notional value'' shall be calculated for each 
such futures position by multiplying the size of the contract, in 
contract units, by the current market price per unit and for each such 
option position by multiplying the size of the contract, in contract 
units, by the strike price per unit;
* * * * *

    Issued in Washington, DC, on October 22, 2002, by the 
Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 02-27309 Filed 10-25-02; 8:45 am]
BILLING CODE 6351-01-P