The Securities and Exchange Commission announced Friday it will propose additional rules governing the use of derivatives by mutual funds, exchange-traded funds and other registered investment companies.
The proposed rules would place restrictions on funds’ use of derivatives and require them to implement risk management measures, which Chairwoman Mary Jo White said during the commission meeting Friday will give investors greater access to information, and will enable the SEC to better monitor risks in the asset management industry.
These latest steps follow related proposals announced in May to enhance data reporting and in September to improve fund liquidity management. “Today’s recommendation builds on that work by proposing enhanced protections that better address risks related to the use of derivatives by registered funds. Inadequate controls on the use of derivatives can create significant risks for funds themselves and investors, as well as raise questions about the potential impacts on the broader financial system,” Ms. White said.
The three main components of the proposal are placing a fixed limit on a fund’s notional exposure, rules for segregating assets and risk management programs. Commissioner Kara Stein said at the meeting that the proposal “answers a pressing question” at the SEC on how to address the increasing use of derivatives by mutual funds and ETFs. One question, she said, is “what limits need to be put on such transactions.”
Attorney Matthew Kerfoot, a partner with law firm Dechert, who advises investment managers that have alternative registered funds, said the proposed rule “will likely be complex and nuanced, but my initial impression is that the use of mark-to-market calculations for asset coverage may provide more flexibility for managers than many of us previously thought. Of course, it remains to be seen how much additional capital will be needed for the risk-based cushion, and the inability to offset transactions to address asset coverage could be a real problem for funds that extensively use derivatives.”
Investment Company Institute President and CEO Paul Schott Stevens said in a statement his group welcomes the SEC’s latest derivatives proposal but called it complex. “It will take the fund industry some time to fully assess its breadth and implications,” Mr. Stevens said.
