SIFMA, IAA Balk at SEC Plan to Limit Derivatives in Mutual Funds

Industry trade groups are coming out against the Securities and Exchange Commission’s proposed portfolio limits in the agency’s plan governing mutual funds’ use of derivatives.

SEC Chairwoman Mary Jo White noted the Commission’s approval in December of the proposed rule regarding the use of derivatives by funds during her Tuesday remarks at the Mutual Fund Directors Forum’s annual policy conference in Washington.

The proposal, which the Investment Adviser Association and the Securities Industry and Financial Markets Association have said needs work, also includes an oversight role for fund directors.

White said Tuesday that the plan would require the board of a fund to approve one of two alternative portfolio limitations on the fund’s use of derivatives and to approve policies and procedures for managing risks associated with the fund’s derivatives transactions. 

Comments on the derivatives proposal were due Monday. The proposal is the third in a series of rulemakings designed to enhance the SEC’s risk monitoring and regulatory safeguards for funds and the asset management industry.

Both IAA and SIFMA told the SEC in their comment letters they opposed the plan’s proposed portfolio limits.

IAA said in its comment letter that the SEC’s derivatives proposal would, for the first time, “condition compliance with Section 18 of the Investment Company Act on the cumulative exposure of all of a fund’s derivatives transactions, financial commitments and indebtedness.”

The SEC proposed a basic cap of 150%, with an exception that would allow up to 300% exposure if the fund met an additional test, the IAA explains. “This represents a significant change in the SEC’s approach to regulating funds’ use of derivatives and would supersede decades of guidance,” IAA said. “The use of caps would also, by the SEC’s own admission, cause some currently operating funds to cease operating as registered investment companies.”

Karen Barr, IAA’s president and CEO, said that “it is not appropriate for the SEC to retroactively determine that a particular investment should no longer be available — especially after the funds were created based on an adviser’s good faith understanding of decades-old Commission and staff positions.”

Investors, Barr added, “may have invested in these funds to diversify their portfolios, pursue returns uncorrelated with the broader securities markets, or in the case of market volatility, to protect their retirement or other savings and investments.”

Timothy Cameron, managing director and head of SIFMA’s Asset Management Group, told the SEC in his comment letter that the proposed portfolio limits “are not the best means to achieve the SEC’s policy objectives, as they could create perverse incentives for portfolio managers to invest in riskier, less liquid instruments and would restrict regulated funds from engaging in risk management and portfolio management activity that otherwise may be beneficial for investors.”

The SEC’s policy objectives, Cameron said, “would be better addressed through the proposed rule’s asset segregation requirements, as well as prospectus disclosure and effective risk management.” 

“If the SEC is disinclined to eliminate portfolio limits,” he continued, SIFMA “urges revisions to the portfolio limits.”