This post is the third in a series that outlines key considerations for investment funds and their advisers regarding the application of the U.S. commodity laws to cryptocurrency derivatives. This post is intended to be a primer on the topic and is not legal advice. You should consult with your counsel regarding the application of the U.S. commodity laws to your particular facts and circumstances.
In Part 1, we focused on the status of cryptocurrencies as commodities and how that status relates to the jurisdiction of the U.S. Commodity Futures Trading Commission (the “CFTC”). In Part 2, we provided an overview of the regulation of commodities and the commodity markets under the Commodity Exchange Act (the “CEA”), explaining in particular that while the authority to prevent fraud and manipulation may apply to any transaction in interstate commerce that involves a commodity, the CFTC’s “substantive regulation” applies only if a transaction involves a “commodity interest“.
Here, in Part 3, we explain why the concept of a commodity interest can be described as the “lynch pin” to substantive regulation of CPOs and CTAs.
Understanding Commodity Interests: A Key to Understanding U.S. Commodity Laws (Or, Why These Are the Interests of Interest)
The definitions of the terms commodity pool, CPO and CTA in sections 1a(10), 1a(11) and 1a(12) of the CEA, respectively, include a reference to commodity interests. At the risk of over-simplifying the statutory language, here is our attempt to provide a plain English application of these definitions in the general context of an investment fund:
- If a fund invests or even has the ability to invest in commodity interests, then the fund will be a commodity pool and its operator will be a CPO and will be required to register with the CFTC as such or qualify for an exemption from registration.
- Similarly, an adviser that provides advice or holds itself out as providing advice for compensation or profit about commodity interests will be a CTA that needs to consider registration or exemption from registration as such.
As a result, the term commodity interest serves as the “lynch pin” to the substantive regulation of CPOs and CTAs (as well as other market intermediaries, such as firms that broker, deal or facilitate the execution of cryptocurrency derivative transactions).
For this reason, funds and advisers should analyze each investment to determine whether it is or may be a commodity interest.
- Some investments may constitute what we refer to as “orthodox commodity interests” (for those familiar, we are re-purposing the “orthodox investment company” concept under Section 3 of the Investment Company Act of 1940 or the “ICA of 1940”). The prime example of such an interest is an exchange-traded futures contract. The analysis of such a commodity interest is not complicated – if it were a duck, it would be quacking.
- But, the analysis of other crypto investments can be extremely nuanced and involve what we refer to as “inadvertent commodity interests” (again borrowing from the vocabulary of Investment Company Act regulation). In these situations, a particular token or transaction that involves a token may have characteristics that could result in that token or transaction being treated as a commodity interest, even if the token seller does not intend for that token to be a commodity interest. For example, if a token provides financial returns determined by reference to an identified asset without conveying an ownership interest in that asset, then the token could be a type of commodity interest.
Finally, one point is worth emphasizing (and, to an extent, repeating). As previously alluded to, being able to invest in a commodity interest is as important as actually investing in a commodity interest for purposes of the CPO and CTA regulatory analyses. So, disclosure in an offering memorandum stating that a fund is permitted to invest in orthodox commodity interests is sufficient to raise CPO and CTA analytical considerations, even if the fund does not actually invest in those interests.
So, having set the stage in this post as to why commodity interests are of interest to funds and advisers, our next post will explore the term commodity interests in greater detail.
Good day. Good background on why these interests are of interest? DR2.