Alternative Investment Management Association Representing alternative asset managers globally
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Recent changes to certain U.S. Commodity Futures Trading Commission (CFTC) rules mean fund managers trading most kinds of derivatives may be required to confirm to their prime broker(s) whether or not their portfolios are “U.S. Persons”. This new definition differs from U.S. Person definitions employed in other U.S. regulations and consequently fund managers must consider its applicability to them. These changes may require a manager’s confirmation to its prime broker(s) or other swap counterparties as to whether or not any funds, managed accounts, or other collective investment vehicles it manages or advises are U.S. Persons. This rule change will in most cases have no implications for a manager if it: (i) has no US investors or enters into swaps not subject to US reporting requirements; or (ii) has counterparties already required to make swap reporting to US regulators. Note, however, that if the manager uses a US-based prime broker, it may be required to make this confirmation in any event.
On 12 July 2013, the CFTC adopted final guidance1 (the “Guidance”) concerning the regulation of cross-border swap transactions mandated by Title VII of the Dodd-Frank Act2. Under Section 2(i) of the Commodity Exchange Act as newly amended, the CFTC will apply certain new rules to swap activities3: (i) taking place outside the U.S. having a direct and significant “nexus”4 with activities in, or effect on, U.S. commerce; or (ii) that contravene CFTC regulations adopted for the purpose of preventing evasion of the swaps provisions.
The Guidance provides a definition of the term “U.S. Person” to be employed used by U.S. swap providers (“Definition”) which has the effect of expanding the CFTC’s extraterritorial framework and providing an aggressive approach to the CFTC’s application of its swap regulations to non-U.S. entities. Consequently, many funds, collective investment vehicles and managed accounts (“Portfolios”) previously outside of the CFTC’s swap jurisdiction may now become subject thereto, which may require certain additional reporting and recordkeeping requirements.
U.S. Person Definition
Pursuant to the Guidance governing the CFTC’s extraterritorial framework, a U.S. Person is:
i. any natural person who is a resident of the United States;
ii. any estate of a decedent who was a resident of the United States at the time of death;
iii. any corporation, partnership, limited liability company, business or other trust, association, joint-stock company, fund, or any form of enterprise similar to any of the foregoing (other than an entity described in Item (iv) or (v) below) (“legal entity”), in each case that is organized or incorporated under the laws of a state or other jurisdiction in the United States or having its principal place of business in the United States;
iv. any pension plan for the employees, officers, or principals of a legal entity described in Item (iii) above, unless the pension plan is primarily for foreign employees of such entity;
v. any trust governed by the laws of a state or other jurisdiction in the United States, if a court within the United States is able to exercise primary supervision over the administration of the trust;
vi. any commodity pool, pooled account, investment fund, or other collective investment vehicle that is not a legal entity described in Item (iii) above and that is majority-owned by one or more persons described in Item (i), (ii), (iii), (iv), or (v) above, except any commodity pool, pooled account, investment fund, or other collective investment vehicle that is publicly offered only to non-U.S. persons and not offered to U.S. Persons;
vii. any legal entity (other than a limited liability company, limited liability partnership, or similar entity where all of the owners of the entity have limited liability) that is directly or indirectly majority-owned by one or more persons described in Item (i), (ii), (iii), (iv), or (v) above and in which such persons bear unlimited responsibility for the obligations and liabilities of the legal entity; and
viii. any individual account or joint account (discretionary or not) where the beneficial owner (or one of the beneficial owners in the case of a joint account) is a person described in Item (i), (ii), (iii),(iv), (v), (vi), or (vii) above.
This definition became effective 9 October 2013.
CFTC interpretation of the rules
While the Definition is for the most part relatively unambiguous, there may be entities not appearing to be explicitly captured thereunder but which nevertheless may be U.S. Persons based upon the CFTC’s interpretation5. Accordingly, managers must consider various facts and circumstances when conducting an assessment of their Portfolio(s) which include, inter alia, the:
Despite the potentially broad application of these criteria, the Guidelines did offer certain specific guidance which can be applied by managers, as follows.
A. Principal Place of Business Test
The “principal place of business” of a Portfolio for determining U.S. Person status under Item (iii) of the Definition is the location of its investment manager, investment advisor, sponsor and promoter(s), or the “actual center of direction, control and coordination”. The CFTC will consider a Portfolio’s principal place of business to be US-based if it has US-based senior personnel responsible for either: (i) the “formation and promotion” of the vehicle; or (ii) the “implementation of the vehicle’s investment strategy.6” Thus, the presence of a key portfolio manager or senior principal in the U.S. could result in the Portfolio being deemed a U.S. Person. The CFTC indicated that the location of the entity’s board of directors is not relevant7.
It was made clear that where a U.K. or Asian-based manger has a U.S. presence, the Portfolio will not be deemed a U.S. Person where certain of its investment personnel or an independent (i.e. third party) sub-adviser’s personnel are US-based, so long as such personnel report to persons outside the U.S. responsible for providing the “key functions relating to the vehicle’s formation or the achievement of its investment objectives8.”
B. Majority Ownership Test
Item (vi) of the Definition includes as a U.S. Person a Portfolio which is majority-owned by one or more U.S. Persons. The Guidance states that, generally, a Portfolio would not need to “look through” to its indirect owner for purposes of determining its status as such, except that it would need to consider the beneficial owners of any other legal entity invested therein controlled by or under common control with the Portfolio. For example, a Master Fund would need to look to the U.S. Person status of the investors in its Feeder Fund(s) where the Master and Feeder Funds are under common control9. The Guidance indicates that where such a control relationship cannot be readily determined the Portfolio (and by implication the Directors and appointed manager) may rely (absent indications to the contrary) upon a written representation from the investor(s) concerning their status as a U.S. Person. This same element of the Definition provides an explicit exemption from the U.S. Person definition any Portfolios publicly offered only to Non-U.S. Persons and which are not open to investment by U.S. Persons, the CFTC having recognized that verification of the identity of owners of publicly offered collective investment vehicles is difficult10.
Implications for managers
1. Investment managers to a Portfolio(s) organized or operated outside of the U.S. must determine whether or not they are U.S. Persons pursuant to the Definition, and may be required to give written confirmation regarding their U.S. Person status to their prime broker and other swap counterparties. Accordingly, if they have not already done so, investment managers should consult with these parties promptly to determine what, if any, impact the Definition may have on their trading operations and relationships. For example, certain swap counterparties themselves may become subject to number of new U.S. regulatory obligations related to swap reporting and recordkeeping and in some cases may request their counterparties to enter into the ISDA 2012 DF Protocol or otherwise amend relevant agreements to facilitate their compliance thereto.
2. The “look-through” described above may be burdensome for non-U.S. managers to implement, as the new Definition differs from the current SEC and CFTC “U.S. Person” definitions, and existing client representations in material Portfolio documentation (e.g. a Subscription Agreement) may not capture it. Managers of Portfolios operating outside the U.S. are advised to canvass their investors with respect to the Definition and actively monitor the proportion of such persons relative to the total number of Portfolio investors, as an amount exceeding 50 per cent. will deem the Portfolio itself a U.S. Person. Potentially, certain managers may elect to turn away prospective U.S. investors or redeem current U.S. investors so as to remain below this threshold.
3. Another consideration is the nature of the instruments traded by the Portfolio. Certain types of instruments fall under the jurisdiction of the SEC (e.g. swaps on individual securities and “narrow-based” securities indices) and accordingly the SEC’s U.S. Person definition is relevant, whereas others fall under the jurisdiction of the CFTC (e.g. commodity swaps and essentially all other swaps) and for which the Definition will be applicable. Accordingly Portfolios trading swaps only subject to SEC jurisdiction will not be subject to the Guidelines. Note the CTFC’s jurisdiction encompasses “mixed swaps”, swaps having elements of both a security and a commodity, such a total return swap on a non-U.S. dollar denominated equity security.
4. If a Portfolio is not a U.S. Person by virtue of the nationality of its investors, it can avoid falling under the ambit of the CFTC swap provisions by trading only with swap counterparties not U.S. Persons under the Definitions. In such case it would be prudent for the Portfolio’s investment manager or Directors to obtain written confirmation from such counterparties attesting to the same and amend their transaction documentation accordingly.
 Interpretive Guidance and Policy Statement regarding Compliance with Certain Swap Regulations, 78 Fed. Reg. 45292 (26 July 2013).
 The Dodd–Frank Wall Street Reform and Consumer Protection Act and its various regulatory penumbras, a gift from the 111th United States Congress in 2010 to American lawyers and compliance consultants.
 “Swap activities” includes activities of a registered swap dealer or major swap participant related to swaps and any product used to hedge such swaps, inter alia, futures, options, other smaller security-based swaps, debt or equity securities, foreign security, physical commodities, and other derivatives.
 This is triggered where swap activities occurring outside the United States involve a U.S. Person (Guidance at 45302).
 “Elements of the Definition are not exhaustive and that there may be circumstances not fully addressed by their specific provisions or where they do not clearly indicate whether a person falls thereunder” (Guidance at 45316).
 Guidance at 45309-10.
 The CFTC indicated that while they having the legal authority to manage the overall business of the entity and specifically to hire and fire the investment managers, do not have the function of actually implementing the investment objectives of funds, and so would not be viewed as “key personnel.” Additionally, the locations of the vehicle’s board meetings, registered office, or books and records are generally not relevant to the vehicle’s U.S. Person status.
 Guidance at 45311, n207.
 This definition captures natural persons that are physically located in the United States and entities that are either incorporated or have their principal place of business in the United States. An investment vehicle may also be considered a U.S. Person if it is majority-owned by one or more U.S. Persons. For this purpose, the CFTC defines “majority-owned” to mean the beneficial ownership of more than 50 percent. of the equity or voting interests in the investment vehicle.
 Guidance at 45314.
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