Futures and forex traders that have developed trading strategies suitable for outside clients may be candidates to develop a successful commodity advisory business focused on trading futures, forex, or swaps. Although many effective traders do not have a large network of investor contacts and may not have the skill-set to solicit investor capital, many successful managed account businesses are built around a partnership of individuals that can collectively commit the attributes needed to realize success. This article covers the major considerations in the process to launch a commodity trading advisor (“CTA”), a term that refers to an advisory firm that manages client assets in trading strategies focused on futures (including commodity futures, index futures, rate futures, and others), over-the-counter foreign currencies (known as “forex”), swaps, commodity and leveraged ETFs, and other derivatives regulated by the Commodity Futures Trading Commission (“CFTC”).
Overview – Process to Start a CTA
The process to start a CTA is reasonably straightforward and can be accomplished in a matter of weeks with the assistance of experienced counsel. Although the process can vary somewhat depending on the specific circumstances of the manager, the process to start a CTA generally involves:
- refining trading strategies and systems
- forming the entity that will serve as the CTA firm (generally an LLC or corporate entity formed in the manager’s home state)
- taking necessary examinations and filing a registration application with the CFTC (unless an exemption is available)
- filing a membership application with the National Futures Association (“NFA”) for both the CTA firm and its Principals
- developing a customer account agreement and risk disclosure document (which must be approved for use by NFA in the case of registered CTAs)
- creating compelling marketing communication materials (such as a “pitchbook” and “tear sheet”) to market the CTA client offering
- opening bank and brokerage accounts for the CTA firm to process advisory fees and expenses
- developing a coherent marketing strategy to convey the trader’s edge and competitive position
- soliciting prospective clients and executing customer agreements
- implementing the investment strategy across “live” client accounts
Additionally, registered CTAs will need to develop a robust compliance program to avoid costly and unwanted regulatory entanglement.
Most futures and forex traders will need to register with the Commodity Futures Trading Commission and will be required to become members of the NFA prior to managing client accounts for compensation. Generally, the only exemption available to traders that exercise discretionary authority over client accounts requires that the firm have not more than 15 clients in any 12-month period and not hold itself out to the public generally as a commodity trading advisor. “Holding out to the public as a CTA” is a potentially very low standard of conduct which is likely to include any active solicitation activity directed at any prospective investors other than close friends and family.
Traders that do not exercise discretionary authority over clients’ accounts and only publish their trading ideas in a newsletter format can generally avoid CTA registration, as well. The principals of a registered CTA who are involved in client solicitation activities will be required to take and pass the Series 3 examination. The Series 34 examination will also be necessary if the CTA trades forex for client accounts.
As with many asset management businesses, the biggest challenge is usually generating interest from prospective clients and aggregating enough assets to make the business viable. Although consistently delivering above-market returns and developing a track record with an attractive risk-reward profile is a significant hurdle, the competition for investor dollars is intense, and having success from a capital raising perspective requires a diligent effort.
Registered CTAs must craft solicitation material carefully to meet NFA’s guidelines or risk sanctions. However, despite NFA’s specific rules, startup CTAs can use hypothetical or back-tested performance results in marketing materials. CTAs can use third-party referral sources, however, for registered CTAs these third-party solicitors will generally need to be licensed as Associated Persons of the CTA. Associated Persons must comply with the examination requirement in the same way as employees of the CTA that conduct solicitation activities.
Other Issues Related to Launching a CTA
CTAs can offer multiple trading programs to prospective clients through the same CTA firm and generally under the same managed account agreement. While it is important that clients receive appropriate disclosure regarding the programs that they select.
A CTA that trades any securities for client accounts may have to register as an investment advisor depending on where the CTA firm is based and other factors. Exemptions from registration are available in certain states, but most states will require registration as an investment advisor prior to a CTA managing client assets in strategies that involve the trading of any securities.
Launch a Commodity Trading Advisor – Let’s Get Started
If you’re ready to begin the process to start a CTA, please contact us to schedule a complimentary consultation to answer any questions that you may have and to learn more about the timeline and costs to launch a CTA firm.