Registered CPOs and CTAs: Prepare for June 30 Changes to NFA Forms PQR and PR
June 14, 2017
Beginning with the second quarter 2017 filings, registered commodity pool operators (CPOs) and commodity trading advisors (CTAs) (collectively, Registrants) will need to report financial information regarding their own operations on National Futures Association (NFA) Forms PQR and PR, respectively.1 The new information includes two financial ratios for the Registrant – current assets/current liabilities and total revenue/total expenses (New Ratios) – that the NFA will use to evaluate trends relating to a Registrant’s financial condition. Previously, all financial information reported on these forms related to the commodity pools and accounts that the Registrants operate and/or advise.
In advance of the reporting deadlines (August 14, 2017 for CTAs and August 29, 2017 for CPOs), Registrants should consider the NFA’s guidance on the New Ratios and determine how to calculate the New Ratios, especially if they do not already calculate these ratios for other reasons.
Background
The New Ratio reporting regime follows several years of NFA consideration of different potential regulatory requirements to address the volume of member responsibility actions (MRAs) the NFA had then brought against registered CPOs and CTAs. A majority of those MRAs involved CPOs or CTAs: operating with insufficient assets to operate as a going concern; misusing client assets; or making misstatements in reports to investors or regarding performance results.
On January 23, 2014, the NFA published a Notice to Members requesting comment on several proposals to increase commodity pool and account investor protections.2 A number of these proposals were met with significant industry opposition as the proposed requirements would either have involved a significant change in Registrant business operations or would have been duplicative with other requirements that already applied to Registrants.
After reviewing member feedback, on November 17, 2016 the NFA published an Interpretive Notice announcing that it would be adding the New Ratios to Forms PQR and PR, but not setting any minimum capital or other financial requirements for CPOs and CTAs. On December 19, 2016, the NFA published a Notice to Members providing advance notice to Registrants that compliance with the New Ratio reporting requirement would be required for the reports as of the end of the second quarter 2017.
Calculating and Reporting the New Ratios
Current Assets/Current Liabilities Ratio
This New Ratio divides a Registrant’s current assets3 by its current liabilities,4 providing a measure of a Registrant’s liquidity. This New Ratio is based on a Registrant’s current asset and current liability balances at the reporting quarter-end.
Total Revenue/Total Expenses Ratio
This New Ratio divides a Registrant’s total revenue5 by its total expenses,6 measuring a Registrant’s operating margin. The New Ratio must reflect the total revenue earned and total expenses incurred during the prior 12 months.
The NFA provided for a phased-in implementation of this item. If a Registrant does not have the requisite data for periods prior to the first reporting quarter, it will only be required to report from June 30, 2017 forward, eventually having a report covering rolling 12-month period. However, if a Registrant does have the requisite data, it should report the data available even if that data covers periods before the second quarter of 2017.
Additional NFA Guidance
Any Registrant that is dually-registered as a CPO and CTA will only be required to report the New Ratios once per quarter. The Registrant will report the New Ratios on Form PR, the first report that the dual Registrant must submit for a given quarter. Form PR is due 45 days following the end of the calendar quarter.
The NFA has indicated that each New Ratio should be presented as a positive number and that, if the Registrant calculates a negative number, the Registrant should report the absolute value of the calculated number.
If the result of a Registrant's calculation of a New Ratio is zero, the form will generate an additional question on elements of the relevant New Ratio. The intent is for the second question to give the NFA enough information that it would not need to ask follow-up questions for that quarter. However, if the NFA finds that a pattern of zeros is reported, it may follow up with the Registrant.
There will be no “free form” field in which Registrants can discuss assumptions made in calculating the New Ratios. The NFA expects Registrants to keep data underlying their calculations as required records, and to make those records available to the NFA during on-site audit or upon request. Further, the NFA expects Registrants to be in a position to discuss assumptions with NFA staff, and to demonstrate how they calculated the New Ratios. Registrants are encouraged to calculate the New Ratios consistently quarter-to-quarter.
In recognition of the fact that some Registrants are subsidiaries of a holding company, the NFA will permit Registrants to report the New Ratios at the subsidiary level or the parent/holding company level. The Registrant will indicate whether it is a subsidiary in a holding company structure and will indicate at which level it will report.
In recognition of the fact that some Registrants have a fiscal year that does not align with the calendar reporting quarters of Forms PQR and PR, a Registrant may base its calculations of the New Ratios as of the calendar quarter-end or as of the Registrant’s fiscal quarter-end within the relevant calendar quarter, so indicating on the form. If the Registrant indicates that the New Ratios are not based on a calendar quarter-end, the Forms PQR and PR will ask as of what date the New Ratios are being reported.
All reporting must be calculated using the accrual method of accounting and in accordance with generally accepted accounting principles or another internationally recognized accounting standard. This may create complications for firms that use cash basis accounting.
The new questions should appear in Easyfile in early July. A template of the new questions as they will appear in Easyfile should be available on the NFA website around the same time.
NFA Workshop Guidance and Additional Resources
On May 10, 2017, NFA staff members held a workshop to assist Registrants with preparing for calculating and reporting the New Ratios. The slides from the NFA New York workshop (which include screenshots of the portions of Forms PQR and PR) are available on the NFA website. A recording of the workshop is also available on the NFA website.
NFA Interpretive Notice No. 9071 provides additional helpful information for making these calculations.
As of the publication of this OnPoint, it is our understanding that the NFA is considering certain “help texts” or frequently asked questions relating to the calculation of the New Ratios. Registrants with complex business structures may identify numerous questions when calculating the New Ratios on an initial basis, and it will be important to raise these questions with the NFA to inform the NFA’s staff. Dechert is prepared to provide these questions to the NFA staff on a no-names basis in order to assist them with drafting help text instructions.
Footnotes
1) NFA Compliance Rule 2-46; NFA Interpretive Notice No. 9071, NFA Compliance Rule 2-46: Reporting Financial Information on NFA Forms PQR and PR (Nov. 17, 2016). Even though some Registrants only have an annual CFTC reporting requirement, all registered CPOs file NFA Form PQR quarterly and all registered CTAs file NFA Form PR quarterly.
2) Notice I-14-03, Request for Comments – CPO/CTA Capital Requirements and Customer Protection Measures (Jan. 23, 2014). For example, one proposal would have required registered CPOs and CTAs to meet a minimum capital requirement.
3) “Current assets” are cash and other assets that can be readily converted to cash within one year. Current assets for a CPO or CTA include (among others): cash, marketable securities, short-term investments, accounts receivable, and a general partner's investment in its pool.
4) “Current liabilities” are obligations that are reasonably expected to be paid within one year. Current liabilities for a CPO or CTA include (among others): accounts payable, accrued expenses, payroll liabilities, income tax liabilities, and interest payable. A Registrant’s long-term financial obligations that are not due within the present accounting year are considered a noncurrent liability and should not be included in this ratio.
5) “Total revenue” is gross income earned by a Registrant from its normal business activities before deduction of any expenses. Income may be received as cash or a cash equivalent and is typically generated by a CPO or CTA through management and/or incentive fees.
6) “Total expenses” are costs incurred in a Registrant’s efforts to generate revenue, representing the cost of doing business. Expenses of a CPO or CTA may include (among others): wages and salaries, rent, utilities, depreciation, and bad debts.
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