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The Securities and Exchange Commission voted to propose a new rule designed to enhance the regulation of the use of derivatives by registered investment companies, including mutual funds, exchange-traded funds (ETFs) and closed-end funds, as well as business development companies.
“Today’s proposal is designed to modernize the regulation of funds’ use of derivatives and safeguard both investors and our financial system,” said SEC Chair Mary Jo White. “Derivatives can raise risks for a fund, including risks related to leverage, so it is important to require funds to monitor and manage derivatives-related risks and to provide limits on their use.”
The Investment Company Act limits the ability of funds to engage in transactions that involve potential future payment obligations, including derivatives such as forwards, futures, swaps and written options. The proposed rule would permit funds to enter into these derivatives transactions, provided that they comply with certain conditions.
Under the proposed rule, a fund would be required to comply with one of two alternative portfolio limitations designed to limit the amount of leverage the fund may obtain through derivatives and certain other transactions.
A fund would also have to manage the risks associated with their derivatives transactions by segregating certain assets in an amount designed to enable the fund to meet its obligations, including under stressed conditions.
A fund that engages in more than a limited amount of derivatives transactions or that uses complex derivatives would be required to establish a formalized derivatives risk management program.
The proposed reforms would also address funds’ use of certain financial commitment transactions, such as reverse repurchase agreements and short sales, by requiring funds to segregate certain assets to cover their obligations under such transactions.
The proposal will be published on the Commission’s website and in the Federal Register. The comment period for the proposal will be 90 days after publication in the Federal Register.