The Securities and Exchange Commission released for public comment Friday a proposed rule that would restrict and limit mutual funds and exchange-traded funds’ use of derivatives, and also require such funds to put risk management measures in place.
SEC Chairwoman Mary Jo White said at the meeting at SEC headquarters in Washington that the proposal is part of the Commission’s agenda to identify and address risks in today’s asset management industry, which has more than $18 trillion in registered fund assets and $67 trillion in assets managed by registered investment advisors.
“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,” White said.
The proposal would create a “modernized, comprehensive regulatory framework to reflect the evolution of funds’ use of derivatives,” and would require funds to meet certain conditions to monitor and manage their risk in order to rely on an exemption from certain statutory restrictions, and in some cases, would also limit a fund’s use of derivatives, she said.
Under the proposed rule, which is out for a 90-day comment period, 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.
–Under the exposure-based portfolio limit, a fund would be required to limit its aggregate exposure to 150% of the fund’s net assets. A fund’s “exposure” generally would be calculated as the aggregate notional amount of its derivatives transactions, together with its obligations under financial commitment transactions and certain other transactions.
–Under the risk-based portfolio limit, a fund would be permitted to obtain exposure up to 300% of the fund’s net assets, provided that the fund satisfies a risk-based test (based on value-at-risk). This test is designed to determine whether the fund’s derivatives transactions, in aggregate, result in a fund portfolio that is subject to less market risk than if the fund did not use derivatives.