Alternative Investment Management Association
US domiciled advisers to hedge funds and many non-US domiciled advisers to hedge funds with US person investors are primarily regulated under the provisions of the Investment Advisers Act of 1940.
An investment manager of a hedge fund that has one or more US investors may be required to register with (i) the Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940 (the ‘Advisers Act’) and/or (ii) the Commodity Futures Trading Commission as a commodity pool operator and/or a commodity trading advisor.
Securities Exchange Commission (SEC)
An investment adviser to a fund which allows investment by one or more US investors must be registered with the SEC or exempt from SEC registration. Many advisers to hedge funds had previously avoided registration with the SEC under the Advisers Act by relying on an exemption for investment advisers with fewer than 15 clients (with each fund advised counting as only one client) which did not hold themselves out to the public as investment advisers (often referred to as the private adviser exemption). The Dodd-Frank Act, which was enacted on 21 July 2010, amended the Advisers Act, eliminating the private adviser exemption and thus requiring advisers to private funds to register with the SEC unless the adviser can rely on an alternative registration exemption.
Commodity Futures Trading Commission (CFTC)
Operators (Commodity Pool Operators – ‘CPOs’) and advisers (Commodity Trading Advisors – ‘CTAs’) of funds that are offered to US persons and transact in “commodity interests” (which includes commodity futures, retail foreign exchange contracts and most swaps) must register with the CFTC or be exempt from registration. From 2003 until the CFTC’s regulatory overhaul of its Part 4 rules, Rule 4.13(a)(4) provided a broad unlimited trading exemption for CPOs of private funds from CFTC registration and regulation. In February 2012, the CFTC finalised its amendments to the Part 4 Rules and rescinded the CPO exemption under Rule 4.13(a)(4). CPOs of funds currently relying on the 4.13(a)(4) exemption will be required to either: (i) stop transacting in commodity interests; (ii) limit such trading and seek to qualify under Regulation 4.13(a)(3) (a de minimis trading exemption) and file for such exemption with the NFA; or (iii) register the pool operator with the CFTC as a CPO. Managers that choose to register with the CFTC may still be able to rely on certain disclosure, reporting and recordkeeping relief, but will be subject to other compliance obligations for CPOs set forth in the CFTC regulations.
On 17 July 2010, US President Obama enacted the Dodd-Frank Act into law. Title VII of the Dodd-Frank Act creates new requirements for the trading, clearing and reporting of the details of swap and security-based-swap contracts.
Implementation of Title VII is divided among the Commodity Futures Trading Commission (CFTC), which is responsible for the regulation of swaps, and the Securities and Exchange Commission (SEC), which is responsible for the regulation of security-based-swaps.
Under the Dodd-Frank Act certain derivatives that have traditionally been traded over-the-counter will now be required to be cleared through a derivatives clearing organization (DCO) or clearing agency and derivatives contracts deemed unsuitable for clearing will be subject to increased margin and capital requirements.
The SEC and CFTC are charged with making the determination regarding which of the Dodd-Frank categories, types and groups of swaps will be subject to clearing requirements. Swaps are required to be cleared through a DCO and security-based swaps through a clearing agency.
The CFTC has already issued its first mandatory clearing requirement with respect to certain interest rate and credit default swaps (so-called ‘covered swaps’). Category I entities (swap dealers, major swap participants, security-based swap dealers, major security-based swap dealers and active funds (200 swaps per month)) will be required to clear covered swaps entered into on or after 11 March 2013. Category 2 entities (commodity pools, private funds other than active funds, and financial entities (including entities predominantly engaged in activities that are in the business of banking or activities that are financial in nature)) will be required to clear covered swaps entered into on or after 10 June 2013. All other entities will be required to clear covered swaps entered into on or after 9 September 2013. Covered Swaps entered into by counterparties that fall within different counterparty categories will be subject to the later of the two applicable compliance dates.
Cross-border application of CFTC and SEC rules
The Dodd-Frank Act provides for the application of both its swap and security-based swap provisions to apply cross-border activities when certain conditions are met. The manifestation of the CFTC and SEC’s interpretation of the relevant sections of the Dodd-Frank Act which relate to the cross-border reach of their respective rules, can be seen in various pieces of rule-making and guidance, including:
· the SEC Proposed Rules and Guidance that would apply to cross-border security-based swap transactions (issued 1 May 2013, comments due by 21 August 2013); and
· the CFTC Final Guidance and an Exemptive Order that would apply to cross-border swap transactions (issued 12 July 2013).
CFTC Exemptive Order on cross-border swaps (July 2013)
SEC Cross-Border Security-Based Swap Activities; Re-Proposal of Regulation SBSR and Certain Rules and Forms Relating to the Registration of Security-Based Swap Dealers and Major Security Based Swap Participants (May 2013)
Margin and Segregation rules
AIMA Response - SEC Capital, Margin, and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements for Broker-Dealers (February 2013)