Interpretive Notices

9062 - NFA COMPLIANCE RULE 2-45: ADDITIONAL GUIDANCE ON TRANSACTIONS NOT SUBJECT TO THE PROHIBITION OF LOANS BY COMMODITY POOLS TO CPOS AND AFFILIATED OR RELATED ENTITIES

(Board of Directors, August 20, 2009; effective September 11, 2009. Effective date of amendments: September 13, 2013; February 5, 2015 and March 24, 2026.)

INTERPRETIVE NOTICE

NFA has taken a number of Member Responsibility Actions (MRAs) against commodity pool operators (CPOs) and CPO principals/associated persons (APs) who directly or indirectly loaned or advanced pool assets to the CPO, its principal(s)/its principle(s)/AP(s) or an affiliated person or entity. Many of these arrangements were used by these principals to purchase luxury items, while others went to related entities that did not have sufficient assets to repay the loans. In each case, the transaction resulted in significant losses to participants' funds.

Therefore, NFA's Board of Directors adopted NFA Compliance Rule 2-45 to prohibit a CPO from permitting a commodity pool to make a direct or indirect loans or advance of pool assets to the CPO, its principal(s), or any other affiliated or related entities. NFA Compliance Rule 2-45 (a)(1)-(3) provides certain exceptions to this prohibition. The purpose of this Interpretive Notice is to provide additional guidance on those transactions that are not prohibited by the Rule.

Subsection (a)(1) of Compliance Rule 2-45 allows a CPO to engage in an otherwise prohibited loan or advance transaction; provided the CPO is an SEC registered investment adviser or is affiliated with one or more SEC registered advisers and the CPO, along with any affiliated SEC registered investment adviser(s), collectively manage(s) at least $1.5 billion in assets and for the pool that makes the loan or advance, the CPO files an exemption for the pool under CFTC Regulations 4.13 or 4.7 or operates the pool pursuant to CFTC No-Action Letter 25-50. A CPO must comply with Section (a)(1)'s AUM and pool exemption requirements at the time the CPO permits a pool to make the loan or advance and at the time that material modifications (e.g., increase the loan amount or extend its duration) to the loan or advance may occur.

Subsection (a)(1)(i) requires that the CPO maintain certain specified records relating to the loan or advance. Specifically, a CPO shall maintain records that demonstrate at the time of the loan or advance and any material modifications to its terms: (a) the loan or advance is for the benefit of the lending pool's participants; (b) the CPO reasonably believes that the recipient of the loan or advance is financially able to repay the loan or advance as set forth under its terms; and (c) the CPO reasonably believes that the terms of the loan or advance, including the consideration to be paid or received, are commercially reasonable and fair. The CPO should create these records at the time a pool first enters into the loan or advance transaction, update the records if there are any material modifications to the loan and maintain the records throughout the duration of the loan and advance and for 5 years thereafter. Section (a)(1)(ii) requires a CPO throughout the duration of the loan or advance to regularly monitor the recipient's compliance with the terms of the loan or advance. In the event of the recipient's non-compliance with the loan or advance's terms, the CPO is required to take actions (as appropriate) that it reasonably determines to be in the best interests of the lending pool. A CPO should also maintain records demonstrating it has satisfied the ongoing monitoring obligations and, in the event of noncompliance, the evaluation it undertook to determine what appropriate actions, if any, it took in the best interests of the pool.

Subsection (a)(2) permits a CPO that is a registered investment company or business development company to engage in transactions that are permitted pursuant to the Investment Company Act of 1940 (ICA), exemptive rules promulgated under the ICA, exemptive orders issued by the Securities and Exchange Commission (SEC) or no action letters issued by SEC staff pursuant to Sections 17 or 57 of the ICA.

Subsection (a)(3) identifies transactions that the Board has determined are not prohibited by Compliance Rule 2-45 provided they are engaged in under the conditions specified. These transactions have the characteristics of a loan or advance but are engaged in by CPOs on a regular basis and as part of their normal course of business. Provided these transactions are engaged in under the circumstances described below, as applicable, they are not considered a prohibited loan or advance under NFA Compliance Rule 2-45.

Certain Securities Borrowings/Securities Loans

In order to take a short position in a security, a pool must locate and borrow the security that is being sold short and deliver it to the purchaser in order to settle the short sale. A pool that is selling a security short may locate and borrow the security from a pool operated by the same CPO — from which the security can be easily located — since the CPO of both pools is fully aware of the securities that are available in the lending pool's portfolio. This type of transaction would not violate Compliance Rule 2-45 provided that no later than the close of business on the day of the securities loan, the pool lending the security has received from the pool borrowing the security collateral with a market value at least equal to the market value of the borrowed security.

Securities Loans for Cash Financing

A pool may raise cash using otherwise idle securities positions held by it by "loaning" these securities to an affiliate as part of a prime brokerage service, and receiving cash based on the market value of these securities. These transactions are typically documented and effected in accordance with a standard form agreement — Master Securities Loan Agreement (MSLA) — provided to the industry by the Securities Industry and Financial Markets Association. Although the transaction is documented as a securities loan, from the pool's perspective the transaction involves the borrowing of cash from its affiliate secured by the pool's long securities position. This type of transaction does not violate NFA Compliance Rule 2-45, provided that: (i) the transaction is cleared by an affiliated prime broker that is registered with the Securities and Exchange Commission as a broker-dealer, is a member of FINRA, the Depository Trust Company and the National Securities Clearing Corporation; and (ii) the transaction is documented under a MSLA.

Guarantee Obligations

One or more pools may make a direct or indirect debt or equity investment in a subsidiary or other affiliated entity for tax, legal, regulatory, or other reasons. Because, among other reasons, the entity will often have a limited amount of capital, the pool(s) will often guarantee or otherwise support (e.g., by pledging collateral) certain of the entity's obligations and a pool will provide such guarantees or support in accordance with the pool's relative investment in the entity from time to time. If the obligee draws upon the guarantee or other credit support, then the amount drawn may become a debt to the pool(s). This type of investment and guarantee or other credit support does not violate NFA Compliance Rule 2-45 provided that a pool is not liable for an amount that is materially above its proportionate share (based on the pool's relative investment in the entity from time to time).

Wholly-Owned Subsidiaries of a Pool

A CPO may for tax, legal, regulatory, or other similar reasons, cause a loan to be made from a pool to a wholly-owned subsidiary¹, without violating Compliance Rule 2-45 provided the following:

(a) The CPO causes a single pool to make a loan directly or indirectly² to a single wholly-owned subsidiary that is formed for trading or investment purposes and is operated by a registered CPO provided that: (1) the subsidiary is formed solely to benefit the pool that made the loan; (2) the financial statements of the subsidiary and the pool making the loan are prepared in accordance with U.S. GAAP³; (3) any outside participant in the pool qualifies as a qualified eligible participant⁴; (4) the loan is not used for a purpose that is otherwise prohibited by NFA rules (e.g., as a conduit for an indirect loan to the CPO or an affiliate of the CPO); or

(b) The CPO or affiliated CPOs cause pools⁵ to make loans directly or indirectly to a wholly-owned subsidiary (collectively owned by the pools) that is a registered broker-dealer and/or registered futures commission merchant provided that: (1) the subsidiary is formed solely to provide clearing and other prime brokerage services to the pools that made the loan; (2) the pools make any loans on the same terms; (3) the loan amounts are proportionate in size to each pool's relative equity ownership of the subsidiary; (4) any outside pool participants in the pools making the loans receive a separate complete disclosure of the terms of the loan, including but not limited to, the loan's principal amount, interest rate and repayment schedule, and any other material information regarding the transaction prior the loan(s) being made; (5) any outside pool participants in a pool making a loan(s) is given a right to redeem in full prior to the loan(s) being made; (6) the loans are not used for a purpose that is otherwise prohibited by NFA rules (e.g., as a conduit for an indirect loan to the CPO or an affiliate of the CPO); and (7) the CPO provides NFA's Member Oversight Department with written notification of the loan(s) and the disclosure provided to outside pool participants prior to the loan(s) being made.

Repurchase Agreements and Reverse Repurchase Agreements

Affiliated pools may engage in repurchase agreements/reverse repurchase agreements in which there is a sale of securities combined with a contemporaneous agreement for the seller to buy back the securities at a later date at a higher price. The party that originally buys the securities effectively acts as a lender of cash. The party that originally sells the securities effectively acts as a borrower of cash using its securities as collateral for the cash loan at a fixed rate of interest. For the party selling the securities and agreeing to repurchase them in the future, this transaction is considered a repurchase agreement. For the party buying the securities and agreeing to resell them at a later date, this transaction is considered a reverse repurchase agreement. These types of transactions between affiliated pools do not violate NFA Compliance Rule 2-45 because the buyer's possession of the securities effectively collateralizes the buyer's exposure in respect to the seller's obligation to repurchase the securities.

Tax-Related Distributions

Tax rules relating to pools treated as partnerships for tax purposes are complex and give rise to circumstances that are difficult to predict and plan for. In particular, the CPO (or a related party) is often required to pay tax on its share of a pool’s income whether or not it has actually received an income distribution from the pool. Accordingly, many pools have contractual provisions, disclosed to and agreed to by its participants, that expressly permit the CPO (or a related party) to receive distributions from the pool based upon the CPO's (or a related party's) share of the pool's taxable income. In addition, some pools may make loans or advances to the CPO (or a related party) to enable it to meet tax obligations. These tax-related loans, advances, or distributions (collectively, distribution) do not violate NFA Compliance Rule 2-45 provided that (a) they are made in strict accordance with the provisions of the pool’s organizational documents that expressly permit the distribution; (b) they relate solely to the CPO's (or related party's) taxable income arising from the pool (and not to any other income), and (c) if the CPO's (or related party's) taxable income arising from operating the pool is ultimately lower than that on which the distribution was based, thus resulting in an excess distribution amount having been made, the CPO shall ensure that repayment is made to the pool, in a manner determined by the CPO and as promptly as reasonably practicable, of (i) any portion of the excess distribution not already paid to an applicable tax authority and (ii) with respect to any portion of the excess already paid to a tax authority, any refund or credit received with respect to such payment.

Member CPOs are reminded of their obligation pursuant to NFA Compliance Rules 2-10 and 2-5 to make any books and records available upon request to NFA relating to any of the transactions described above.

¹ For purposes of this exclusion only, a subsidiary will be considered to be wholly-owned even though a general partner, managing member, or similar entity (collectively, a "managing entity") controlled by the CPO owns a small equity interest (i.e., less than 5%) in the subsidiary. The managing member's equity interest in the subsidiary should be in proportion to the size of the managing member's relative debt/equity contribution to the subsidiary. Moreover, if a managing entity makes a loan to the subsidiary, then the managing entity's loan should be on terms no more favorable than the pool(s).

² For example, a pool may make a loan to a first-tier wholly owned subsidiary that, in turn, makes an equity contribution or loan to a second-tier wholly owned subsidiary.

³ The financial statements of the subsidiary and the pool making the loan may be prepared, as applicable, in accordance with International Financial Reporting Standards provided it is permitted by the CFTC's rules and requirements.

⁴ The provision relating to qualified eligible participants does not apply to pools registered under the Investment Company Act of 1940.

⁵ Provided the conditions in this subsection are satisfied, a single CPO may cause a loan to be made from a single pool to a wholly-owned subsidiary of the pool for tax, legal, regulatory, or other similar reasons.