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| USCI > SEC Filings for USCI > Form 10-Q on 9-Aug-2012 | All Recent SEC Filings |
9-Aug-2012
Quarterly Report
The following discussion should be read in conjunction with the condensed financial statements and the notes thereto of the United States Commodity Index Funds Trust (the "Trust") included elsewhere in this quarterly report on Form 10-Q.
Forward-Looking Information
This quarterly report on Form 10-Q, including this "Management's Discussion and Analysis of Financial Condition and Results of Operations," contains forward-looking statements regarding the plans and objectives of management for future operations. This information may involve known and unknown risks, uncertainties and other factors that may cause the Trust's actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by any forward-looking statements. Forward-looking statements, which involve assumptions and describe the Trust's future plans, strategies and expectations, are generally identifiable by use of the words "may," "will," "should," "expect," "anticipate," "estimate," "believe," "intend" or "project," the negative of these words, other variations on these words or comparable terminology. These forward-looking statements are based on assumptions that may be incorrect, and the Trust cannot assure investors that the projections included in these forward-looking statements will come to pass. The Trust's actual results could differ materially from those expressed or implied by the forward-looking statements as a result of various factors.
The Trust has based the forward-looking statements included in this quarterly report on Form 10-Q on information available to it on the date of this quarterly report on Form 10-Q, and the Trust assumes no obligation to update any such forward-looking statements. Although the Trust undertakes no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, investors are advised to consult any additional disclosures that the Trust may make directly to them or through reports that the Trust in the future files with the U.S. Securities and Exchange Commission (the "SEC"), including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
Introduction
The United States Commodity Index Fund ("USCI"), the United States Copper Index Fund ("CPER"), the United States Agriculture Index Fund ("USAG") and the United States Metals Index Fund ("USMI") are each a commodity pool that issues units representing fractional undivided beneficial interests in USCI, CPER, USAG and USMI, respectively ("units"), that may be purchased and sold on the NYSE Arca, Inc. (the "NYSE Arca"). USCI, CPER, USAG and USMI are series of the Trust, a Delaware statutory trust formed on December 21, 2009. USCI, CPER, USAG and USMI are collectively referred to herein as the "Trust Series." The Trust and each Trust Series operate pursuant to the Trust's Second Amended and Restated Declaration of Trust and Trust Agreement (the "Trust Agreement"), dated November 10, 2010. Wilmington Trust Company (the "Trustee"), a Delaware banking corporation, is the Delaware trustee of the Trust. The Trust and each Trust Series are managed and controlled by United States Commodity Funds LLC ("USCF").
United States Commodity Index Fund
USCI invests in futures contracts for commodities that are traded on the New York Mercantile Exchange (the "NYMEX"), ICE Futures ("ICE Futures"), Chicago Board of Trade ("CBOT"), Chicago Mercantile Exchange ("CME"), London Metal Exchange ("LME"), Commodity Exchange, Inc. ("COMEX") or on other foreign exchanges (such exchanges, collectively, the "Futures Exchanges") (such futures contracts, collectively, "Futures Contracts") and, to a lesser extent, in order to comply with regulatory requirements or in view of market conditions, other commodity-based contracts and instruments such as cash-settled options on Futures Contracts, forward contracts relating to commodities, cleared swap contracts and other over-the-counter transactions that are based on the price of commodities and Futures Contracts (collectively, "Other Commodity-Related Investments"). Market conditions that USCF currently anticipates could cause USCI to invest in Other Commodity Related Investments would be those allowing USCI to obtain greater liquidity or to execute transactions with more favorable pricing.
The investment objective of USCI is for the daily changes in percentage terms of its units' per unit net asset value ("NAV") to reflect the daily changes in percentage terms of the SummerHaven Dynamic Commodity Index Total ReturnSM (the "Commodity Index"), less USCI's expenses. USCF does not intend to operate USCI in a fashion such that its per unit NAV will equal, in dollar terms, the spot prices of the commodities underlying the Benchmark Component Futures Contracts (as defined below) that comprise the Commodity Index or the prices of any particular group of Futures Contracts. The Commodity Index is owned and maintained by SummerHaven Index Management, LLC ("SummerHaven Indexing") and calculated and published by the NYSE Arca. The Commodity Index is comprised of 14 Futures Contracts that are selected on a monthly basis from a list of 27 possible Futures Contracts. The Futures Contracts that at any given time make up the Commodity Index are referred to herein as "Benchmark Component Futures Contracts." USCI invests first in the current Benchmark Component Futures Contracts and other Futures Contracts intended to replicate the return on the current Benchmark Component Futures Contracts and, thereafter may hold Futures Contracts in a particular commodity other than one specified as the Benchmark Component Futures Contract, or may hold Other Commodity-Related Investments that may fail to closely track the Commodity Index's total return movements. If USCI increases in size, and due to its obligations to comply with regulatory limits or due to other market pricing or liquidity factors, USCI may invest in Futures Contract months other than the designated month specified as the Benchmark Component Futures Contract, or in Other Commodity-Related Investments, which may have the effect of increasing transaction related expenses and may result in increased tracking error.
USCI seeks to achieve its investment objective by investing in Futures Contracts and Other Commodity-Related Investments such that daily changes in its per unit NAV closely track the daily changes in the price of the Commodity Index. USCI's positions in Commodity Interests are rebalanced on a monthly basis in order to track the changing nature of the Commodity Index. If Futures Contracts relating to a particular commodity remain in the Commodity Index from one month to the next, such Futures Contracts are rebalanced to the 7.14% target weight. Specifically, on a specified day near the end of each month (the "Selection Date"), it will be determined if a current Benchmark Component Futures Contract will be replaced by a new Futures Contract in either the same or different underlying commodity as a Benchmark Component Futures Contract for the following month, in which case USCI's investments would have to be changed accordingly. In order that USCI's trading does not unduly cause extraordinary market movements, and to make it more difficult for third parties to profit by trading based on market movements that could be expected from changes in the Benchmark Component Futures Contracts, USCI's investments typically are not rebalanced entirely on a single day, but rather typically rebalanced over a period of four days. After fulfilling the margin and collateral requirements with respect to its Commodity Interests, USCF invests the remainder of USCI's proceeds from the sale of units in short-term obligations of the United States government ("Treasuries") or cash equivalents, and/or merely hold such assets in cash (generally in interest-bearing accounts).
United States Copper Index Fund
CPER invests in Futures Contracts for commodities that are traded on the COMEX and, to a lesser extent, in order to comply with regulatory requirements or in view of market conditions, Other Copper-Related Investments (as defined below). Market conditions that USCF currently anticipates could cause CPER to invest in Other Copper-Related Investments would be those allowing CPER to obtain greater liquidity or to execute transactions with more favorable pricing.
The investment objective of CPER is for the daily changes in percentage terms of its units' per unit NAV to reflect the daily changes in percentage terms of the SummerHaven Copper Index Total ReturnSM (the "Copper Index"), less CPER's expenses. USCF does not intend to operate CPER in a fashion such that its per unit NAV will equal, in dollar terms, the spot prices of the commodities underlying the Benchmark Component Copper Futures Contracts (as defined below) that comprise the Copper Index or the prices of any particular group of Futures Contracts. The Copper Index is designed to reflect the performance of the investment returns form a portfolio of copper futures contracts. The Copper Index is owned and maintained by SummerHaven Indexing and calculated and published by the NYSE Arca. The Copper Index is comprised of either two or three Eligible Copper Futures Contracts that are selected on a monthly basis based on quantitative formulas relating to the prices of the Eligible Copper Futures Contracts developed by SummerHaven Indexing. The Eligible Copper Futures Contracts that at any given time make up the Copper Index are referred to herein as "Benchmark Component Copper Futures Contracts."
CPER seeks to achieve its investment objective by investing to the fullest extent possible in the Benchmark Component Copper Futures Contracts. Then, if constrained by regulatory requirements or in view of market conditions, CPER will invest next in other Eligible Copper Futures Contracts, and finally to a lesser extent, in other exchange traded futures contracts that are economically identical or substantially similar to the Benchmark Component Copper Futures Contracts if one or more other Eligible Copper Futures Contracts is not available. When CPER has invested to the fullest extent possible in exchange-traded futures contracts, CPER may then invest in other contracts and instruments based on the Benchmark Component Copper Futures Contracts, other Eligible Copper Futures Contracts or copper, such as cash-settled options, forward contracts, cleared swap contracts and swap contracts other than cleared swap contracts. Other exchange-traded futures contracts that are economically identical or substantially similar to the Benchmark Component Copper Futures Contracts and other contracts and instruments based on the Benchmark Component Copper Futures Contracts, are collectively referred to as "Other Copper-Related Investments," and together with Benchmark Component Copper Futures Contracts and other Eligible Copper Futures Contracts, "Copper Interests."
United States Agriculture Index Fund
USAG invests in Futures Contracts for commodities that are traded on the ICE Futures US, ICE Futures Canada, the CBOT, the CME and the Kansas City Board of Trade ("KCBT") and to a lesser extent, in order to comply with regulatory requirements or in view of market conditions, Other Agriculture-Related Investments (as defined below). Market conditions that USCF currently anticipates could cause USAG to invest in Other Agriculture-Related Investments would be those allowing USAG to obtain greater liquidity or to execute transactions with more favorable pricing.
The investment objective of USAG is for the daily changes in percentage terms of its units' per unit NAV to reflect the daily changes in percentage terms of the SummerHaven Dynamic Agriculture Index Total ReturnSM (the "Agriculture Index"), less USAG's expenses. USCF does not intend to operate USAG in a fashion such that its per unit NAV will equal, in dollar terms, the spot prices of the commodities underlying the Benchmark Component Agriculture Futures Contracts (as defined below) that comprise the Agriculture Index or the prices of any particular group of Futures Contracts. The Agriculture Index is owned and maintained by SummerHaven Indexing and calculated and published by the NYSE Arca. The Agriculture Index is comprised of fourteen Eligible Agriculture Futures Contracts that are selected on a monthly basis based on quantitative formulas developed by SummerHaven Indexing. The Eligible Agriculture Futures Contracts that at any given time make up the Agriculture Index are referred to herein as "Benchmark Component Agriculture Futures Contracts."
USAG seeks to achieve its investment objective by investing to the fullest extent possible in the Benchmark Component Agriculture Futures Contracts. Then, if constrained by regulatory requirements or in view of market conditions, USAG will invest next in other Eligible Agriculture Futures Contracts, and finally to a lesser extent, in other exchange traded futures contracts that are economically identical or substantially similar to the Benchmark Component Agriculture Futures Contracts if one or more other Eligible Agriculture Futures Contracts is not available. When USAG has invested to the fullest extent possible in exchange-traded futures contracts, USAG may then invest in other contracts and instruments based on the Benchmark Component Agriculture Futures Contracts, other Eligible Agriculture Futures Contracts or the agricultural commodities included in the Agriculture Index, such as cash-settled options, forward contracts, cleared swap contracts and swap contracts other than cleared swap contracts. Other exchange-traded futures contracts that are economically identical or substantially similar to the Benchmark Component Agriculture Futures Contracts and other contracts and instruments based on the Benchmark Component Agriculture Futures Contracts, are collectively referred to as "Other Agriculture-Related Investments," and together with Benchmark Component Agriculture Futures Contracts and other Eligible Agriculture Futures Contracts, "Agriculture Interests."
United States Metals Index Fund
USMI invests in Futures Contracts for commodities that are traded on the NYMEX, the LME and the COMEX and, to a lesser extent, in order to comply with regulatory requirements or in view of market conditions, Other Metals-Related Investments (as defined below). Market conditions that USCF currently anticipates could cause USMI to invest in Other Metals-Related Investments would be those allowing USMI to obtain greater liquidity or to execute transactions with more favorable pricing.
The investment objective of USMI is for the daily changes in percentage terms of its units' per unit NAV to reflect the daily changes in percentage terms of the SummerHaven Metals Index Total ReturnSM (the "Metals Index"), less USMI's expenses. USCF does not intend to operate USMI in a fashion such that its per unit NAV will equal, in dollar terms, the spot prices of the commodities underlying the Benchmark Component Metals Futures Contracts (as defined below) that comprise the Metals Index or the prices of any particular group of Futures Contracts. The Metals Index is owned and maintained by SummerHaven Indexing and calculated and published by the NYSE Arca. The Metals Index is comprised of ten Eligible Metals Futures Contracts that are selected on a monthly basis based on quantitative formulas developed by SummerHaven Indexing. The Eligible Metals Futures Contracts that at any given time make up the Metals Index are referred to herein as "Benchmark Component Metals Futures Contracts."
USMI seeks to achieve its investment objective by investing to the fullest extent possible in the Benchmark Component Metals Futures Contracts. Then, if constrained by regulatory requirements or in view of market conditions, USMI will invest next in other Eligible Metals Futures Contracts, and finally to a lesser extent, in other exchange traded futures contracts that are economically identical or substantially similar to the Benchmark Component Metals Futures Contracts if one or more other Eligible Metals Futures Contracts is not available. When USMI has invested to the fullest extent possible in exchange-traded futures contracts, USMI may then invest in other contracts and instruments based on the Benchmark Component Metals Futures Contracts, other Eligible Metals Futures Contracts or the metals included in the Metals Index, such as cash-settled options, forward contracts, cleared swap contracts and swap contracts other than cleared swap contracts. Other exchange-traded futures contracts that are economically identical or substantially similar to the Benchmark Component Metals Futures Contracts and other contracts and instruments based on the Benchmark Component Metals Futures Contracts are collectively referred to as "Other Metals-Related Investments," and together with Benchmark Component Metals Futures Contracts and other Eligible Metals Futures Contracts, "Metals Interests."
Other Defined Terms
The Copper Index, together with the Commodity Index, the Agriculture Index and the Metals Index are referred to throughout this quarterly report on Form 10-Q collectively as the "Applicable Index" or "Indices."
Benchmark Component Futures Contracts, Benchmark Component Copper Futures Contracts, Benchmark Component Agriculture Futures Contracts and Benchmark Component Metals Futures Contracts are referred to throughout this quarterly report on Form 10-Q collectively as "Applicable Benchmark Component Futures Contracts."
Other Commodity-Related Investments, Other Copper-Related Investments, Other Agriculture-Related Investments and Other Metals-Related Investments are collectively referred to herein as "Other Related Investments." Commodity Interests, Copper Interests, Agriculture Interests and Metals Interests are collectively referred to herein as "Applicable Interests."
Futures Contracts and Other Commodity Related Investments are collectively referred to as "Commodity Interests" in this quarterly report on Form 10-Q.
Impact of Accountability Levels, Position Limits and Price Fluctuation Limits. Futures contracts include typical and significant characteristics. Most significantly, the Commodity Futures Trading Commission (the "CFTC") and U.S. designated contract markets such as the NYMEX, COMEX, CME, and CBOT have established accountability levels and position limits on the maximum net long or net short futures contracts in commodity interests that any person or group of persons under common trading control (other than as a hedge, which is not applicable to the Trust Series' investments) may hold, own or control. The net position is the difference between an individual or firm's open long contracts and open short contracts in any one commodity. In addition, most U.S.-based futures exchanges limit the daily price fluctuation for futures contracts. Currently, the ICE Futures imposes position and accountability limits that are similar to those imposed by U.S.-based futures exchanges but does not limit the maximum daily price fluctuation, while some other non-U.S. futures exchanges have not adopted such limits.
The accountability levels for the commodities comprising an Applicable Index and other futures contracts traded on U.S.-based futures exchanges are not a fixed ceiling, but rather a threshold above which such exchanges may exercise greater scrutiny and control over an investor's positions. As of June 30, 2012, USCI, CPER, USAG and USMI held a net of 537 futures contracts traded on NYMEX, 534 futures contracts traded on the COMEX, 1,819 futures contracts traded on the CME, 3,530 futures contracts traded on the CBOT and 1 futures contract traded on the KCBOT. For the six months ended June 30, 2012, no Trust Series exceeded accountability levels.
Position limits differ from accountability levels in that they represent fixed limits on the maximum number of futures contracts that any person may hold and cannot allow such limits to be exceeded without express CFTC authority to do so. In addition to accountability levels and position limits that may apply at any time, the Futures Exchanges may impose position limits on contracts held in the last few days of trading in the near month contract to expire. It is unlikely that a Trust Series will run up against such position limits. A Trust Series does not typically hold the near month contract in its Applicable Benchmark Component Futures Contracts. In addition, each Trust Series' investment strategy is to close out its positions during each Rebalancing Period in advance of the period right before expiration and purchase new contracts. As such, none of the Trust Series anticipates that position limits that apply to the last few days prior to a contract's expiration will impact it. For the six months ended June 30, 2012, no Trust Series exceeded position limits imposed by the NYMEX, COMEX, CME or CBOT.
On October 18, 2011, the CFTC adopted new rules, which establish position limits and limit formulas for certain physical commodity futures, including Futures Contracts and options on Futures Contracts, executed pursuant to the rules of designated contract markets (i.e., certain regulated exchanges) and commodity swaps that are economically equivalent to such futures and options contracts. See "Introduction - Futures Contracts and Position Limits" in this quarterly report on Form 10-Q for information regarding the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act").
The regulation of commodity interests in the United States is subject to ongoing modification by governmental and judicial action. On July 21, 2010, a broad financial regulatory reform bill, the Dodd-Frank Act, was signed into law. All of the Dodd-Frank Act's provisions became effective on July 16, 2011, but the actual implementation of some of the provisions is subject to continuing uncertainty because implementing rules and regulations have not been completely finalized and have been challenged in court. Pending final resolution of all applicable regulatory requirements, some specific examples of how the new Dodd-Frank Act provisions and rules adopted thereunder could impact the Trust Series are discussed below.
Futures Contracts and Position Limits
Provisions in the Dodd-Frank Act include the requirement that position limits be established on a wide range of commodity interests including energy-based and other commodity futures contracts, certain cleared commodity swaps and certain over-the-counter commodity contracts; new registration, recordkeeping, capital and margin requirements for "swap dealers" and "major swap participants" as determined by the new law and applicable regulations; and the forced use of clearinghouse mechanisms for many swap transactions that are currently entered into in the over-the-counter market. The new law and the rules thereunder may negatively impact a Trust Series' ability to meet its investment objective either through limits or requirements imposed on it or upon its counterparties. Further, increased regulation of, and the imposition of additional costs on, swap transactions under the new legislation and implementing regulations could cause a reduction in the swap market and the overall derivatives markets, which could restrict liquidity and adversely affect a Trust Series. In particular, new position limits imposed on each Trust Series or its counterparties may impact a Trust Series' ability to invest in a manner that most efficiently meets its investment objective, and new requirements, including capital and mandatory clearing, may increase the cost of a Trust Series' investments and doing business, which could adversely impact the ability of a Trust Series to achieve its investment objective.
On October 18, 2011, the Commodity Futures Trading Commission (the "CFTC") adopted regulations implementing position limits and limit formulas for 28 core physical commodity futures contracts, including the Futures Contracts and options on Futures Contracts executed pursuant to the rules of designated contract markets (i.e., certain regulated exchanges) and commodity swaps that are economically equivalent to such futures and options contracts (collectively, "Referenced Contracts"). The new regulations require, among other things, aggregation of position limits that would apply across different trading venues to contracts based on the same underlying commodity. However, the regulations would require aggregation of Referenced Contracts held by separate Related Public Funds (as defined below) only if such Related Public Fund had "identical trading strategies." USCF does not believe any of the Related Public Funds should be viewed as having identical trading strategies for purposes of the CFTC's aggregation rules.
Although the regulations became effective on January 17, 2012, the position limit rules will be implemented in two phases: spot-month position limits and non-spot-month position limits. Spot-month limits will be effective sixty days after the term "swap" is defined under the Dodd-Frank Act (see below). The limits adopted will be based on the spot-month position limit levels currently in place at applicable futures exchanges (or designated contract market or "DCM"). Thereafter, the spot-month limits will be adjusted annually for energy contracts. These subsequent limits will be based on the CFTC's determination of deliverable supply in consultation with the futures exchanges. Spot-month position limit levels will be set generally at 25% of estimated deliverable supply, and limits will be applied separately for physical-delivery and cash-settled contracts in the same commodity.
Non-spot-month position limits will go into effect by CFTC order after the CFTC has received one year of open interest data on physical commodity cleared and uncleared swaps under the swaps large trader reporting rule. The non-spot month limits will be adjusted biennially based on Referenced Contract open interest. Non-spot-month position limits (i.e., limits applied to positions in all contract months combined or in a single contract month) will be set using the 10/2.5 percent formula: 10 percent of the contract's first 25,000 of open interest and 2.5 percent thereafter. These limits will be reset biennially based on two years of open interest data.
On December 2, 2011, the Securities Industry and Financial Markets Association ("SIFMA") and the International Swaps and Derivatives Association ("ISDA") filed a lawsuit challenging the CFTC's position limits rule. The lawsuit asserts that the position limits rule inadequately fulfills the required cost-benefit analysis. It is not known at this time what effect this lawsuit will have on the implementation of the new position limits rule.
Based on its current understanding of the final position limit regulations, USCF does not anticipate significant negative impact on the ability of each Trust Series to achieve its investment objective. However, as of the filing of this quarterly report on Form 10-Q, additional studies are required to be conducted before all requirements of the final rules are implemented, and therefore, it . . .
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