I often tell aspiring traders looking to launch their programs that trading is hard, but it is only half the battle. Running a business that manages customer accounts and expectations, complies with regulations, and grows assets is just as vital. The CFTC is set to make that job a bit more difficult starting on March 26, 2025. They will implement new accreditation standards for what is considered a QEP (Qualified Eligible Participant) that will impact who can invest in a futures trader unless that firm goes through extra regulatory steps that will cost time and money. Let us review that standard and why it exists in the first place.
Background on QEPs and the Regulatory Change
In 1992, the CFTC (Commodity Futures Trading Commission) introduced the concept of QEP. The stated rationale was to limit “risky” investments to those with significant net worth who were sophisticated enough to understand the choices. Their threshold of $2 million in liquid securities or $200k in margin stayed in place until the change set to go into effect next month. At that time, the standard will double to $4 million liquid and/or $400k in margin. Despite few complaints and limited issues with the so-called 4.7 exemption, an internal group at the CFTC believed that the new level would catch up to inflation, which made it necessary. Managed Funds Associations and other trade groups opposed this change.
Criticism of the New QEP Standard
Alternatives to this arbitrary level exist, as evidenced by the SEC standard that considers both customer asset levels, education, and experience. A cardiologist with $4 million in assets might achieve the net worth to invest but might display less knowledge than a financial advisor with just $2 million in their account. Knowledge of alternatives is currently much more ubiquitous with the internet and financial podcasts, among other avenues, than in 1992. According to the Federal Reserve’s Survey of Consumer Finances (SCF), only 2-3% of all Americans can achieve the older standard and even less than 2% will clear the new threshold. This happens at a time when crypto, hedge funds, and private equity become available to an ever-widening group of people.
Impact on Futures Trading and the Industry
The 4.7 Exemption is practically the industry standard at this point. Minimum investment sizes of $250k and higher require almost a $2 million net worth from the start. Additionally, the regulatory burden is much lighter than full CFTC registration. This makes it an easier route to get off the ground as disclosure documents do not need to be approved regularly, financial reporting is limited, and annual compliance costs come in lower. This allows the manager to charge lower fees and run with fewer employees. Given that most of these strategies open in fully transparent separate accounts, the investor sees all the returns anyway.
Consequences for Aspiring CTAs
Aspiring CTAs will take the biggest hit as the hurdle to begin trading and cover their costs will be higher. It takes time to build a track record and attract clients. Most fail because they do not accumulate assets quickly enough because of poor returns and/or weak marketing. Companies like IASG help provide a platform to get to a critical mass but only the exceptional ones survive. This will result in fewer choices for consumers. Many of the largest funds already deal with institutional customers and have the operational ability to comply with heavy regulations. This will make the largest funds even bigger. I expect that new CTAs will choose the full registration route, but many customers will switch to fund investments that allow accredited investors instead.
How Firms Are Responding
Companies like Le Mans Trading, which runs the Hyperion Fund and the Bowmoor Aggressive Fund, are already taking steps to get fully registered with the CFTC. With fresh staff entering the agency in conjunction with the new Trump administration, there might be a rush of other firms going down the same path. Fortunately, those that have already been invested will be grandfathered in so they will not be forced to redeem. If we see a major correction in the equity markets, interest in alternatives will spike. The new rules will get attention then, but the damage might be done already. The window for the old level will stay open until March 26, 2025. If you are considering an investment, now might be the time to act.
Photo by Sean Pollock on Unsplash