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MFA and AIMA Recommend Modifications to SEC Proposal on Investment Companies' Use of Derivatives

The Managed Funds Association ("MFA") and the Alternative Investment Management Association ("AIMA") recommended modifications to the SEC's proposal to enhance regulation on the use of derivatives by registered investment companies and business development companies.

As previously covered, Investment Company Act Rule 18f-4 ("Exemption from the requirements of section 18 and section 61 for certain senior securities transactions") would provide certain exemptions for mutual funds, exchange-traded funds, registered closed-end funds and business development companies (collectively, "funds") when entering into derivatives transactions, subject to certain conditions.

In their comment letter, the MFA and AIMA stated that they support the proposal's objective of limiting excessive speculation. The associations criticized the proposal's relative value-at-risk ("VaR") test as the default limit on funds' use of derivatives, asserting that the proposed method fails to (i) consider the diversity of funds and (ii) take account of other means of risk management. The MFA and AIMA made several recommendations, including:

  • allowing funds to select either an absolute or a relative VaR test;
  • raising absolute and relative VaR test limits to 20% and 200%, respectively;
  • providing funds with seven calendar days to come back into compliance after a VaR test breach; and
  • eliminating (i) the "time out" period after a breach of the VaR test, (ii) the sales practice rule for leveraged/inverse funds, and (iii) the requirement to publicly report derivatives exposures and VaR test breaches.

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