Commodity trading advisor

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A commodity trading advisor (CTA) is US financial regulatory term for an individual or organization who is retained by a fund or individual client to provide advice and services related to trading in futures contracts, commodity options and/or swaps. [1] [2] They are responsible for the trading within managed futures accounts. The definition of CTA may also apply to investment advisors for hedge funds and private funds including mutual funds and exchange-traded funds in certain cases. [3] CTAs are generally regulated by the United States federal government through registration with the Commodity Futures Trading Commission (CFTC) and membership of the National Futures Association (NFA). [4]

Contents

Characteristics

Trading activities

A CTA generally acts as an asset manager, following a set of investment strategies utilizing futures contracts and options on futures contracts on a wide variety of physical goods such as agricultural products, forest products, metals, and energy, plus derivative contracts on financial instruments such as indices, bonds, and currencies. [5] The trading programs employed by CTAs can be characterized by their market strategy, whether trend following or market neutral, and the market segment, such as financial, agricultural or currency. [5]

There are three major styles of investment employed by CTAs: technical, fundamental, and quantitative. Technical traders invest after analysing chart patterns. They often employ partially automated systems, such as computer software programs, to follow price trends, perform technical analysis, and execute trades. Successful trend following, or using technical analysis techniques to capture swings in markets may drive a CTA's performance and activity to a large degree. In 2010, Dr. Galen Burghardt, adjunct professor at the University of Chicago's Booth School of Business, found a correlation of 0.97 between a subset of trend following CTAs and a broader CTA index from the period 2000-2009, indicating that speculative technical trend following had been dominant within the CTA community. [6] Fundamental traders attempt to forecast prices by analyzing supply and demand factors, amongst other market information, in their attempt to realize profits. Other non-trend following CTAs include short-term traders, spread trading and individual market specialists. [7] Fundamental CTA's typically invest based on analysis of the core markets they are trading, by analysing weather patterns, farm yields, understanding oil drilling volumes etc. Quantitative CTA's do statistical or quantitative analysis on market price patterns and try to make predictions based on such research. Many Quantitative CTA's have backgrounds in science, mathematics, statistics and engineering. [8] [ citation needed ]

Compensation

A CTA is often compensated through management fees calculated as an annual percentage of equity in the fund and incentive fees calculated as a percentage of new trading profits. Usually no incentive fees are charged if the CTA does not generate a profit exceeding a hurdle rate or high-water mark. For investors it is noteworthy to consider the impact of the risk free rate and the impact that has on hurdle rates and compensation for a particular manager. [9] [10]

Performance

CTA Performance has been challenging over the last decade and investors have debated the beneficial characteristics of CTAs and trend followers at length. While one can argue that markets trends have been dominated by central banks' actions, thereby limiting the potential of trends to develop, one can also argue that central bank policy has started several trends in risky assets. Investors need to carefully judge the investment program, where past performance has not been indicative of future results but where research-oriented efforts have been a clear focus for managers trying to raise assets and outcompete other futures managers. That said, most investors evaluate CTA based on past performance using a variety of different techniques. CTA performance data tends to be freely available to qualified investors and can be found for instance at BarclayHedge, [11] EurekaHedge, [12] NilssonHedge [13] and a large number of other hedge fund databases.

History

In the United States, trading of futures contracts for agricultural commodities dates back to at least the 1850s. [14] The first Federal regulation aimed at futures trading was proposed in the early 1920s, leading to the passage of the Grain Futures Act in 1922. In 1936, this law was replaced by an amended version named the Commodity Exchange Act. [14] [15] The "commodity trading advisor" was first recognized in legislation in 1974, when the Commodity Futures Trading Commission (CFTC) was established under the Commodity Futures Trading Commission Act. [15] [16] The name CTA was adopted since the advisors originally operated predominantly within the commodities markets. Later, trading expanded significantly following the introduction of derivatives on other products including financial instruments. [5] [15]

In July 2010, the definition of commodity trading advisor under the Commodity Exchange Act was expanded by the Dodd-Frank Wall Street Reform and Consumer Protection Act to include "persons who provide advice on swap transactions". Prior to this, swaps were not included in the CTA definition. [17] [18]

Regulation

Historical regulation

In 1979, the CFTC adopted the first comprehensive regulation for commodity trading advisors, which was later strengthened by additional rules in 1983 and 1995. The additional rules in 1983 increased the CFTC's oversight of such advisors and authorized the National Futures Association (NFA) to carry out processing of registration for entities including CTAs. [19] [20] Those adopted in 1995 aimed to increase disclosure by CTAs leading to increased knowledge and understanding for investors. [21]

Current regulation

Under the Commodity Exchange Act, CTAs must register with and conform to the regulations of the CFTC, including providing records and reports, unless they meet the Commission's criteria for exemption. [1] [22] Registered CTAs must also become members of the NFA if they manage funds or provide advice to members of the public. [23]

Under the Commodity Exchange Act qualifying individuals may be exempted from CTA registration with the CFTC, including if their primary business is not as a CTA, they are registered with the Securities and Exchange Commission as an investment advisor, and if they have not provided trading advice to more than 15 persons. If an individual is exempt from registration, they must still file with the NFA. [24] A CTA is exempt from registration with the NFA if they have provided commodity trading advice to fewer than 15 people and do not generally use the title commodity trading advisor, or if they provide advice only through publications, a computerized system or seminars. [23]

Nonetheless, exempt CTAs are still regulated in some form. They are still subject to CFTC rules concerning market manipulation as well as the anti-fraud provisions of the CEA. They additionally need to file a public notice disclosing their existence and exempt status. They must provide an offering memorandum to their investors, as well as a quarterly account statement and an annual report. In addition, exempt CTAs are subject to “special call” provision, where they are, amongst other things, required to file special reports to the CFTC. These reports are used for market surveillance as well as for investigations or litigation cases. [25]

Changes following Dodd-Frank

On January 26, 2011, following the 2010 enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the CFTC made additions and amendments to the regulation of CTAs, including two new forms of data collection. The CFTC also increased disclosure requirements and amended the registration criteria. [22] Due to these changes, advisors managing funds that use swaps or other commodity interests may be defined as CTAs, subject to registration with the CFTC. [3] The United States Chamber of Commerce and the Investment Company Institute filed a lawsuit against the CFTC, aiming to overturn this change to rules that would require the operators of mutual funds investing in commodities to be registered, but the lawsuit was unsuccessful and the rule change was upheld. [26]

Exemption from registration under the Investment Advisers Act of 1940

If a commodity trading advisor engages in significant advisory activities regarding securities, it could be required to register under the Investment Advisers Act of 1940 (Advisers Act). However, most commodity trading advisors are able to rely on an exemption from registration set forth in Section 203(b)(6) of the Advisers Act. This exemption is available to registered commodity trading advisors whose business does not consist primarily of acting as an investment adviser. [27]

Related Research Articles

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<span class="mw-page-title-main">Commodity market</span> Physical or virtual transactions of buying and selling involving raw or primary commodities

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<span class="mw-page-title-main">Speculation</span> Engaging in risky financial transactions

In finance, speculation is the purchase of an asset with the hope that it will become more valuable shortly. It can also refer to short sales in which the speculator hopes for a decline in value.

<span class="mw-page-title-main">Commodity Futures Trading Commission</span> Government agency

The Commodity Futures Trading Commission (CFTC) is an independent agency of the US government created in 1974 that regulates the U.S. derivatives markets, which includes futures, swaps, and certain kinds of options.

<span class="mw-page-title-main">Commodity Futures Modernization Act of 2000</span> United States federal legislation

The Commodity Futures Modernization Act of 2000 (CFMA) is United States federal legislation that ensured financial products known as over-the-counter (OTC) derivatives remained unregulated. It was signed into law on December 21, 2000 by President Bill Clinton. It clarified the law so most OTC derivative transactions between "sophisticated parties" would not be regulated as "futures" under the Commodity Exchange Act of 1936 (CEA) or as "securities" under the federal securities laws. Instead, the major dealers of those products would continue to have their dealings in OTC derivatives supervised by their federal regulators under general "safety and soundness" standards. The Commodity Futures Trading Commission's (CFTC) desire to have "functional regulation" of the market was also rejected. Instead, the CFTC would continue to do "entity-based supervision of OTC derivatives dealers". The CFMA's treatment of OTC derivatives such as credit default swaps has become controversial, as those derivatives played a major role in the financial crisis of 2008 and the subsequent 2008–2012 global recession.

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A commodity pool is an investment structure where many individual investors combine their moneys and trade in futures contracts as a single entity in order to gain leverage. They are analogous to mutual funds wherein a fund is similarly set up expressly for trading in equity, except that mutual funds are open to public subscription whereas commodity pools and hedge funds are private.

<span class="mw-page-title-main">Financial adviser</span> Professional who renders financial services to clients

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<span class="mw-page-title-main">Winton Group</span>

Winton Group, Ltd is a British investment management firm founded by David Harding. In the United States, Winton is registered with the Securities and Exchange Commission as an investment advisor and with the Commodity Futures Trading Commission as a CTA, and is authorised by the Financial Conduct Authority in the UK. The company trades on more than 100 global futures markets in a wide variety of asset classes and on global equity markets. The firm was launched with $1.6 million in 1997, reached a peak of $28.5 billion in assets under advisement, before dropping to $7.3 billion by late 2020. Winton Group has six offices around the world: London, New York, Hong Kong, Shanghai, Sydney, and Abu Dhabi.

A Commodity pool operator (CPO) is an individual or organization that solicits or receives funds to use in the operation of a commodity pool, syndicate, investment trust, or other similar fund, specifically for trading in commodity interests. Such interests include commodity futures, swaps, options and/or leverage transactions. A commodity pool may refer to funds that trade in commodities and can include hedge funds. A CPO may make trading decisions for a fund or the fund can be managed by one or more independent commodity trading advisors. The definition of CPO may apply to investment advisors for hedge funds and private funds including mutual funds and exchange-traded funds in certain cases. CPOs are generally regulated by the United States federal government through the Commodity Futures Trading Commission and National Futures Association.

A managed futures account (MFA) or managed futures fund (MFF) is a type of alternative investment in the US in which trading in the futures markets is managed by another person or entity, rather than the fund's owner. Managed futures accounts include, but are not limited to, commodity pools. These funds are operated by commodity trading advisors (CTAs) or commodity pool operators (CPOs), who are generally regulated in the United States by the Commodity Futures Trading Commission and the National Futures Association. As of June 2016, the assets under management held by managed futures accounts totaled $340 billion.

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<span class="mw-page-title-main">Securities market participants (United States)</span>

Securities market participants in the United States include corporations and governments issuing securities, persons and corporations buying and selling a security, the broker-dealers and exchanges which facilitate such trading, banks which safe keep assets, and regulators who monitor the markets' activities. Investors buy and sell through broker-dealers and have their assets retained by either their executing broker-dealer, a custodian bank or a prime broker. These transactions take place in the environment of equity and equity options exchanges, regulated by the U.S. Securities and Exchange Commission (SEC), or derivative exchanges, regulated by the Commodity Futures Trading Commission (CFTC). For transactions involving stocks and bonds, transfer agents assure that the ownership in each transaction is properly assigned to and held on behalf of each investor.

<span class="mw-page-title-main">AlphaSimplex Group</span> Asset management firm based in Boston

AlphaSimplex Group (AlphaSimplex) is an American investment management firm based in Boston. The firm relies on quantitative analysis for its approach to investing.

References

  1. 1 2 Lemke, Thomas P.; Gerald T. Lins; Kathryn L. Hoenig; Patricia S. Rube (2012). Hedge Funds and Other Private Funds: Regulation and Compliance 2012-2013 Edition. Thomson West.
  2. ↑ "7 USC § 1A - Definitions". Legal Information Institute. Cornell University Law School. Retrieved 7 June 2012.
  3. 1 2 "The CFTC's final entity rules and their implications for hedge funds and other private funds" (PDF). Sutherland. Sutherland Asbill & Brennan LLP. 10 May 2012. Retrieved 4 June 2012.[ permanent dead link ]
  4. ↑ "NFA BASIC". Background Affiliation Status Information Center (BASIC).
  5. 1 2 3 Gregoriou, Greg N. (2008). Encyclopedia of Alternative Investments. Chapman and Hall/CRC. p. 93. ISBN   978-1420064889 . Retrieved 15 May 2012.
  6. ↑ "Dr. Galen Burghardt: Measuring the impact of trend following in the CTA space". Opalesque.TV. 13 December 2010. Retrieved 15 May 2012.
  7. ↑ "Constructing a managed futures portfolio". Managed Futures Today. November 2010. Archived from the original on 4 December 2014. Retrieved 16 May 2012.
  8. ↑ Valeyre, S. (2024). "Optimal trend-following portfolios". Journal of Investment Strategies. 12.
  9. ↑ "Investors NEC SIC 6799". Gale Group. Archived from the original on 23 March 2010. Retrieved 16 May 2012.
  10. ↑ Spurgin, Richard; Schneeweis, Thomas (8 February 1998). "A Study of Survival: Commodity Trading Advisors, 1988-1996" (PDF). Hedgeworld. University of Massachusetts. Archived from the original (PDF) on 10 March 2013. Retrieved 5 June 2012.
  11. ↑ "BarclayHedge".
  12. ↑ "EurekaHedge".
  13. ↑ "NilssonHedge".
  14. 1 2 Stassen, John H. (1982). "The Commodity Exchange Act in Perspective a Short and Not-So-Reverent History of Futures Trading Legislation in the United States". Washington and Lee Law Review. Washington & Lee University School of Law. 39 (3): 825–843. Retrieved 29 May 2012.
  15. 1 2 3 "History of the CFTC". Commodity Futures Trading Commission. Retrieved 15 May 2012.
  16. ↑ Lhabitant, François-Serge (2007). Handbook of Hedge Funds. Wiley, John & Sons, Incorporated. ISBN   978-0470026632.
  17. ↑ "Dodd-Frank Wall Street Reform and Consumer Protection Act" (PDF). GPO.gov. U.S. Government Printing Office. 21 July 2010. Retrieved 13 June 2012.
  18. ↑ "Q & A – Conforming Amendments to Part 4 Regulations" (PDF). CFTC.gov. Commodity Futures Trading Commission. Retrieved 13 June 2012.
  19. ↑ "CFTC History 1970s". Commodity Futures Trading Commission. Archived from the original on 18 July 2014. Retrieved 15 May 2012.
  20. ↑ "CFTC History 1980s". Commodity Futures Trading Commission. Archived from the original on 16 July 2014. Retrieved 15 May 2012.
  21. ↑ "CFTC History 1990s". Commodity Futures Trading Commission. Archived from the original on 13 August 2014. Retrieved 15 May 2012.
  22. 1 2 "Commodity Pool Operators and Commodity Trading Advisors: Amendments to Compliance Obligations" (PDF). Commodity Futures Trading Commission. Retrieved 14 May 2012.
  23. 1 2 "Commodity Trading Advisor". National Futures Association. Retrieved 14 May 2012.
  24. ↑ "Commodity Pool Operator and Commodity Trading Advisor Exemptions and Exclusions". Commodity Futures Trading Commission. Archived from the original on 16 August 2014. Retrieved 15 May 2012.
  25. ↑ "Commodity trading advisors & commodity pool operator 101" (May 2012). Managed Funds Association" (PDF).
  26. ↑ Investment Company Institute v. CFTC, 891 F. Supp. 2d 162 (D.D.C. Dec. 12, 2012), aff'd, No. 12-5413 (June 25, 2013).
  27. ↑ Lemke and Lins, Regulation of Investment Advisers, § 1:34 (Thomson West, 2013).
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