World News – US – SEC adopts modernized regulatory framework for the use of derivatives by registered funds and business development companies

Washington, DC- (Newsfile Corp – October 28, 2020) – The Securities and Exchange Commission voted today to strengthen the regulatory framework for the use of derivatives by registered investment firms, including including mutual funds (other than money market funds), exchange-traded funds (ETFs) and closed-end funds, as well as business development companies The new rules and rule changes will provide a modernized approach and overall regulation of these funds’ use of derivatives that addresses investor protection concerns and reflects developments over the past decades The Commission is committed to designing regulatory programs that reflect ever-expanding product innovation and investor choice available today hui in the asset management sector of &CloseCurlyQuote, while also taking into account the risks associated with the funds’ increasingly complex portfolio composition and operations

“Derivatives have come to play an important role for many funds in portfolio strategy and risk management, but the regulatory approach to the use of derivatives has been inconsistent and outdated, ” said SEC Chairman Jay Clayton “Today the action of ’ s provides a complete framework for the &CloseCurlyQuote funds; use of derivatives which offers both important protections for investors and regulatory certainty for funds and their advisers It is important to note that the new overall risk limits will prohibit the use of derivatives which is incompatible with the limits leverage imposed by the law on investment companies, but will allow virtually all funds to continue to serve their investors using the most efficient instruments I thank the staff for their awesome work”

The Investment Company Law limits the ability of registered funds and business development companies to engage in transactions that involve potential future payment obligations, including obligations under derivatives such as futures contracts, futures contracts, swaps and written options The new rule allows funds to enter into these transactions if they meet certain conditions intended to protect investors These conditions include the adoption of a derivative risks and compliance with a limit on the amount of risk linked to the leverage that the fund can obtain based on the value at risk, or “VaR”

A simplified set of requirements will apply to funds that use derivatives on a limited basis The rule also allows a fund to enter into reverse repurchase agreements and similar financing transactions, as well as « unfunded liabilities &CloseCurlyDoubleQuote ; to make certain loans or investments, subject to conditions adapted to these transactions Funds, including money market funds, will now be allowed, under the rule, to invest in securities on a forward settlement basis Funds will also be subject to reporting and record keeping requirements regarding their use of derivatives

Finally, the new rule requirements also apply to leveraged and reverse ETFs The Commission asked staff to review the effectiveness of existing regulatory requirements in protecting investors, especially those who have stand-alone accounts, which invest in complex investment products (including leveraged or reverse products) As part of this review, staff will consider whether the Commission’s promulgation &CloseCurlyQuote of any additional requirements for these products may be appropriate Today, Chairman Clayton and Trustees Dalia Blass, William Hinman and Brett Redfearn released a joint statement that addresses concerns with leveraged or reverse funds and other complex products[i]

The new rule will be posted on the Commission website &CloseCurlyQuote and in the Federal Register The rule and associated rule and form changes will take effect 60 days after posting in the Federal Register The Commission has provided for an eighteen-month transition period for funds to comply with the rule and related reporting requirements

TECHNICAL SHEET

Use of derivatives by registered investment companies and business development companies

October 28, 2020

The Commission voted in favor of adopting new rules and changes to rules and forms, intended to provide an up-to-date and comprehensive approach to the regulation of funds’ use of derivatives and certain other transactions The new rule 18f-4, an exemption rule under the Investment Companies Act of 1940 (the « &CloseCurlyDoubleQuote Act;), allows mutual funds (other as money market funds), exchange-traded funds (« ETFs”), registered closed-end funds, and business development companies (collectively, » funds”) to enter into derivative transactions and certain other transactions notwithstanding restrictions under section 18 of the Act As part of these new rules, the Board amended rule 6c-11 of the Act to allow leveraged or reverse ETFs to operate without obtaining an exemption order Finally, the Commission adopted new reporting obligations and changes to some disclosure forms

Rule 18f-4 provides certain exemptions from the law under certain conditions The conditions and other elements of the rule are as follows:

The amendments to rule 6c-11 of the Investment Firms Act allow leveraged and reverse ETFs to rely on rule 6c-11 if they comply with all applicable provisions of the Rule 18f-4 Council rescinds exemption orders previously issued to promoters of leveraged or reverse ETFs as part of these amendments

The funds will be required to make a confidential report to the Commission on a current basis on the N-RN form if the fund does not meet the VaR-based limit on leverage risk for more than five business days Funds currently required to file reports on the N-PORT and N-CEN forms will be required to provide certain information regarding the use of derivatives of a fund ’ s This will include information regarding the &CloseCurlyQuote fund; s VaR, if applicable, and information on the derivative exposure of the &CloseCurlyQuote fund; s (for funds that rely on the limited use of derivatives exception in Rule 18f-4)

The Commission cancels the 1979 policy statement (version 10666) which provided guidance to the Commission on how funds may engage in certain business practices in light of the restrictions in Article 18’ In addition, staff in the Investment Management Division have reviewed their no-action letters and other guidelines regarding funds’ use of derivatives and other transactions covered by rule 18f-4 Some of these letters and staff directives will be withdrawn

The new rule, along with the associated rule and form changes, will be posted on the Commission website &CloseCurlyQuote and in the Federal Register All will be effective 60 days after posting to the Federal Register

Commission provides for a transition period to allow funds time to comply with the provisions of Rule 18f-4 and related reporting requirements The Commission has adopted a compliance date that falls eighteen months after the date Effective Date Cancellation of version 10666 will also come into effect eighteen months after the effective date Staff withdrawal of staff letters and staff directives regarding funds’ the use of derivatives and other transactions covered by rule 18f-4 will be effective upon revocation of version 10666

[i] See President Jay Clayton; Dalia Blass, Director, Investment Management Division; William Hinman, Director, Corporate Finance Division; Brett Redfearn, Director, Trading and Markets Division, “Joint Statement Regarding Complex Financial Products and Retail Investors” (Oct 28, 2020), Available here

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