The National Futures Association (NFA), the U.S. self-regulatory organization of the futures and swaps trading industry, has published a new Interpretive Notice entitled “Disclosure Requirements for NFA Members Engaging in Virtual Currency Activities” (Interpretive Notice). The Interpretative Notice sets forth new disclosure requirements applicable to NFA Member commodity pool operators (CPOs) and commodity trading advisors (CTAs) that trade underlying or spot virtual currencies and/or derivatives on virtual currencies in pools and client accounts. The new disclosure requirements apply to CPO and CTA promotional materials (advertising), disclosure documents and offering documents. In addition to publishing the Interpretive Notice, on August 9, 2018, the NFA provided advance instructions to the market regarding compliance with the Interpretive Notice.
The Interpretive Notice’s disclosure requirements become effective on October 31, 2018 (Effective Date), at which point promotional materials will need to have been updated. After the Effective Date, NFA Members will have a further 21 calendar days until November 21, 2018 (Compliance Date) to bring their disclosure documents and offering documents into compliance. Importantly, the disclosure changes to promotional materials and offering documents detailed below will apply to NFA Members even when they are relying on a registration exemption (for example, under CFTC Rules 4.13(a)(3) or 4.14(a)(8)) or an operational exemption (for example, under CFTC Rules 4.12(c)(3) or 4.7(b) or (c), and together with operating in reliance on a registration exemption, “operating in an exempt capacity”) for a pool or account for which they are trading virtual currencies and/or virtual currency derivatives.
Affected NFA Member CPOs and CTAs operating in an exempt capacity need to be especially aware of these new disclosure requirements. NFA Member CPOs and CTAs operating in an exempt capacity under these exemptions and various other exemptions are otherwise subject to very limited CFTC regulatory disclosure requirements, and there is nothing in the relevant CFTC rules to put an NFA Member on notice that these new NFA disclosure requirements apply. To address this, NFA Member CPOs and CTAs trading virtual currencies and virtual currency derivatives should add the requirements set forth in the Interpretive Notice to their NFA compliance manuals. In addition, the NFA is requiring that existing investors receive updated disclosures by the Compliance Date, which may necessitate an other-than-regular investor notice or mailing. For CPOs and CTAs that are required to file their disclosure documents for review with the NFA, any updated disclosure documents must be filed with and approved by the NFA staff by the Compliance Date in order to be used going forward.
Requirements and Guidelines Applicable to NFA Member CPOs and CTAs Trading Underlying or Spot Virtual Currencies
The Interpretive Notice sets forth guidelines regarding the types of risk disclosures that the NFA would expect to see in promotional materials, disclosure documents and offering documents for pools and accounts in which NFA Member CPOs and CTAs are trading virtual currencies. These risks include (but are not necessarily limited to) those related to: the unique features of virtual currencies; price volatility; valuation and liquidity; cybersecurity; the opaque nature of the spot market; virtual currency exchanges, intermediaries and custodians; the uncertainty of the regulatory landscape applicable to virtual currencies; nascent technology; and increases in transaction fees and their potential effects on performance of a pool or account trading underlying or spot virtual currencies.
In addition, the NFA is mandating that NFA Member CPOs and CTAs trading virtual currencies in any pool or client account prominently display the disclaimer set forth in the Appendix to this Newsflash (Disclaimer), in the promotional materials, disclosure documents and offering documents for applicable products.
The NFA states that the reason for the mandated Disclaimer is to communicate to existing and prospective investors the NFA’s limited oversight role in the virtual currency marketplace. The CFTC has delegated to the NFA certain regulatory authority over commodity interests such as futures, options on futures and swaps; however, underlying or spot virtual currencies are not commodity interests, so the NFA does not have oversight over the actual virtual currency transactions that an NFA Member CPO or CTA would be trading in a pool or client account. Note that the CFTC has jurisdiction to bring certain actions for fraud in the spot market for commodities, and has asserted that certain underlying or spot virtual currencies are commodities that would be subject to its anti-fraud jurisdiction.
For CPOs and CTAs that are required to file their disclosure documents with the NFA staff, disclosure documents that only need to be updated with the Disclaimer in order to be brought into compliance with the terms of the Interpretive Notice may be filed for expedited review or as a supplement, as permitted.
Guidelines Applicable to NFA Member CPOs and CTAs Trading Virtual Currency Derivatives
According to the Interpretive Notice, NFA Member CPOs and CTAs that trade virtual currency derivatives (e.g., Bitcoin futures or swaps on various virtual currencies) must review their promotional materials, disclosure documents and offering documents for pools and separately managed accounts. The disclosures in these documents must reflect the risks associated with virtual currency derivatives trading, as well as the impact these risks could have on performance. NFA Member CPOs and CTAs might determine that their existing disclosures already adequately address these risks, although through the Interpretive Notice the NFA seems to suggest that it considers virtual currency derivatives trading to entail unique risks that need to be addressed with enhanced disclosures. Such risks could include the risks that: virtual currency derivatives may experience significant price volatility; and initial margin for contracts may increase over the life of the contract. Further, futures commission merchants through which a pool or account executes virtual currency futures trades may: require additional initial margin exceeding exchange-set minimums; impose more restrictive position limits than exchange-set maximums; or set other restrictions on a pool or account’s trading. Finally, exchanges may impose trading halts in contracts which can serve to prevent a pool or account from exiting positions during periods of significant price volatility.
Significantly, the NFA is not requiring a set disclaimer to be included in promotional materials, disclosure documents or offering documents for NFA Member CPO and CTA pools and separately managed accounts trading virtual currency derivatives, so long as the NFA Member CPO or CTA is not also trading underlying or spot virtual currencies in that pool or account. However, as noted above, NFA Member CPOs and CTAs need to ensure that existing pool participants and separately managed account clients receive any updated disclosures by the Compliance Date, and that promotional materials are updated by the Effective Date.
Reminder Regarding Other NFA Requirements Related to Virtual Currency and Virtual Currency Derivatives Trading
The new requirements set forth in the Interpretive Notice are not the first related to virtual currency and virtual currency derivatives applicable to NFA Member CPOs and CTAs. As a reminder to NFA Member CPOs and CTAs trading virtual currencies and/or virtual currency derivatives, as of December 14, 2017, NFA Members must update their annual questionnaires to reflect this trading in pools or accounts. As of January 18, 2018, for pools with fiscal year-ends of October 21, 2017 or later, CPOs must answer questions in the NFA Easyfile system as to whether a pool is trading virtual currencies or virtual currency derivatives when filing an annual pool financial statement. Each of these requirements was addressed in a previous NFA Notice to Members available here and here.
Appendix – Disclaimer Applicable to Virtual Currency Activities
[NAME OF NFA MEMBER] IS A MEMBER OF NFA AND IS SUBJECT TO NFA'S REGULATORY OVERSIGHT AND EXAMINATIONS. [NAME OF NFA MEMBER] HAS ENGAGED OR MAY ENGAGE IN UNDERLYING OR SPOT VIRTUAL CURRENCY TRANSACTIONS IN A [COMMODITY POOL OR MANAGED ACCOUNT PROGRAM]. ALTHOUGH NFA HAS JURISDICTION OVER [NAME OF NFA MEMBER] AND ITS [COMMODITY POOL OR MANAGED ACCOUNT PROGRAM], YOU SHOULD BE AWARE THAT NFA DOES NOT HAVE REGULATORY OVERSIGHT AUTHORITY FOR UNDERLYING OR SPOT MARKET VIRTUAL CURRENCY PRODUCTS OR TRANSACTIONS OR VIRTUAL CURRENCY EXCHANGES, CUSTODIANS OR MARKETS. YOU SHOULD ALSO BE AWARE THAT GIVEN CERTAIN MATERIAL CHARACTERISTICS OF THESE PRODUCTS, INCLUDING LACK OF A CENTRALIZED PRICING SOURCE AND THE OPAQUE NATURE OF THE VIRTUAL CURRENCY MARKET, THERE CURRENTLY IS NO SOUND OR ACCEPTABLE PRACTICE FOR NFA TO ADEQUATELY VERIFY THE OWNERSHIP AND CONTROL OF A VIRTUAL CURRENCY OR THE VALUATION ATTRIBUTED TO A VIRTUAL CURRENCY BY [NAME OF NFA MEMBER].