PUBLIC STATEMENTS & REMARKS

Statement of DSIO Director Joshua B. Sterling on Supporting Innovation in Digital Asset Products, including Pooled Investment Vehicles

February 10, 2020

The Division of Swap Dealer and Intermediary Oversight (Division) recognizes that CFTC-registered firms are often at the forefront in product innovation.  This has been the case throughout the CFTC’s history, and it remains true today with the advent of myriad products in the digital asset space.

The Division actively supports the CFTC’s core objective of fostering responsible innovation and enhancing the regulatory experience of market participants, including for our registrants.  We work closely with our colleagues throughout the agency, including the LabCFTC team, to remain well-informed about product innovations and how they intersect with our rule sets for swap dealers, futures commission merchants, commodity pool operators (CPOs), and other registrant categories.  We welcome opportunities to meet with registrants and other market participants to discuss their innovation efforts.

The Division understands that CPOs and other asset managers are exploring whether and how best to offer pooled investment vehicles that trade futures, swaps, and other commodity interests that reference digital assets like Bitcoin and stablecoins.  Generally, vehicles that will do so are considered commodity pools under the Commodity Exchange Act and CFTC regulations.[1]  As such, the operators of those vehicles are considered CPOs and must generally register with the CFTC and comply with certain disclosure, recordkeeping, and reporting requirements in the CFTC’s Part 4 regulations.[2]  Certain exemptions and exclusions from those requirements are available, in whole and in part, depending upon the composition of a given commodity pool’s portfolio, its investor base, and the manner in which the pool markets itself.[3]

A firm that is considering whether to launch a commodity pool should assess whether it needs to register as a CPO and, if so, what requirements will apply with respect to that pool.  In addition, a CPO that is considering whether to launch a commodity pool that trades a mix of commodity interests and securities may have to consider whether that pool is also an “investment company” required to register as such with the Securities and Exchange Commission (SEC) under the Investment Company Act of 1940 (1940 Act), absent an available exemption or exclusion.[4]  This type of determination is highly fact-specific, and it will inform a variety of considerations for how the CPO proceeds with an offering of the pool’s interests. Among those considerations is determining whether the commodity pool must submit its disclosure document for review and approval by the National Futures Association (NFA) before it can be used to solicit investments.

Commodity pools that have registered as investment companies under the 1940 Act do not have to submit their offering documents for review by NFA.  At the same time, registered CPOs that operate pools registered as investment companies remain subject the antifraud provision of the Commodity Exchange Act when they market and offer those pools to investors.[5]  No matter whether a commodity pool is also an investment company, the Commodity Exchange Act makes clear that the offer and sale of the pool’s interests will be subject to the federal securities laws.[6]

The CFTC’s regulations governing commodity pool disclosures contain many important provisions that focus on risks, return characteristics, and associated expenses that are unique to commodity interest trading strategies.  This is true regardless of the asset referenced by a futures contract, swap, or other commodity interest – including Bitcoin and other digital assets.  Disclosures subject to these requirements highlight several important points that may be material to commodity pool investors, including the following:

  • Strategy Disclosure.  A futures contract has no intrinsic worth and will expire after a set time. A futures contract does not pay current income or a dividend; nor does it provide any other basis of return.  For this reason, it may mischaracterize a pool’s investment strategy to state, without sufficient explanatory context, that the pool “invests” in futures contracts.
  • Risk Disclosure.  A futures contract transfers the risk of future price movements from one party to another.  For every gain in futures trading, there is an equal and offsetting loss.  Accordingly, whether a futures trade is profitable for one party depends on whether the price paid, value received, or cost of delivery under the related futures contract is favorable to that party.  This is true regardless of the underlying asset, whether tangible or intangible in nature.  It is important for a fund that trades futures or other commodity interests to describe carefully, in connection with the presentation of its strategy, precisely how those instruments present opportunities for gain or loss.
  • Expense Disclosure.  Commodity pool disclosure documents are also required to include line-item disclosures about fees and expenses associated with commodity interest trading.
  • Principal Disclosures.  Because trading futures and other commodity interests is highly specialized, a commodity pool must present background on the business and educational experience of key personnel who are considered “principals” of the pool’s CPO (or commodity trading advisor).[7]  This information helps investors assess the qualification of the personnel involved to direct or oversee the implementation of the pool’s primary trading strategy.
  • Discussion of Commodity Brokers and Trading Counterparties.  Since commodity interest transactions tend to be highly leveraged, a commodity pool must disclose material information about its commodity brokers and trading counterparties.

These types of disclosures are subject to review by NFA, although not for commodity pools registered as investment companies under the 1940 Act.

The Division has long been, and remains, highly supportive of responsible innovation in our markets, especially when it is driven by our registrants.  The Division staff stands ready to assist innovators and pioneers with compliance inquiries and to facilitate conversations with LabCFTC concerning new products, including pooled investment vehicles that seek exposure to digital assets.  The Division staff want to do our part to help market participants to ensure that these innovations can develop in a way that is consistent with the law.  This offer of assistance extends to productswhether publicly or privately-offeredthat may not be subject to specific CFTC disclosure requirements and disclosure document review by NFA.

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Should market participants have any questions concerning these matters, please contact Division Director Joshua B. Sterling (202.418.6056; [email protected]), Deputy Director Amanda Olear (202.418.5283; [email protected]), or Christopher W. Cummings, Special Counsel (202.418.5445; [email protected]).

 


 

[1] See Section 1a(10) of the Commodity Exchange Act, 7 U.S.C. § 1a(10); 17 C.F.R. § 4.10(d)(1).

[2] See 17 C.F.R. §§ 4.21-4.26.

[3] See, e.g., 17 C.F.R. §§ 4.5, 4.7, 4.12, 4.13.

[4] CPOs considering investment company status questions regarding a commodity pool are encouraged to contact the staff of the SEC’s Division of Investment Management at [email protected] or 202.551.6825.

[5] See Section 4o of the Commodity Exchange Act, 7 U.S.C. § 6o; see also 17 C.F.R. § 4.16 (prohibited representations).

[6] Section 4m(2) of the Commodity Exchange Act, 7 U.S.C. § 6m(2); see also 17 C.F.R. § 4.12(c)(3)(i)(B) (permitting, for CPOs of pools registered as investment companies, substituted compliance for specific Part 4 disclosure requirements with specific requirements applicable under the federal securities laws).

[7] See 17 C.F.R. § 3.1(a) (defining “principal” for these and other purposes).