The SEC reproposed a rule designed to "enhance" regulations on the use of derivatives by registered investment companies and business development companies ("BDCs").
According to the SEC, Proposed Rule 18f-4 under the Investment Company Act of 1940 would provide an exemption from Section 18 under the ICA for mutual funds, exchange-traded funds ("ETFs"), registered closed-end funds and BDCs (collectively, "funds") when entering into derivatives transactions.
The SEC explained that reliance on Proposed Rule 18f-4 would be subject to certain conditions, including:
the establishment of a written derivatives risk management program that includes, among other things, (i) a standardized risk management framework tailored to a fund's particular risks, (ii) the establishment, maintenance and enforcement of risk guidelines, and (iii) periodic review of the program;
designation of a derivatives risk manager by a fund's board of directors;
compliance with an outer limit on fund leverage based on a relative value-at-risk ("VaR") test that compares the fund's VaR and the VaR of a "designated reference index" for the fund; and
compliance to certain recordkeeping requirements.
The proposed rule would except (i) certain funds that use derivatives in a limited way from the derivatives risk management program requirement and the limit on fund leverage, and (ii) certain leveraged/inverse funds from the limit on fund leverage.
In addition, the proposal would create Rule 15l-2 under the Securities Exchange Act and Rule 211(h)-1 under the Investment Advisers Act in order to address sales practices with respect to leveraged or inverse funds and exchange-listed commodity or currency pools (a/k/a "leveraged investment vehicles"). These rules would require broker-dealers and investment advisers to comply with "due diligence and approval" requirements prior to approving an order to buy and sell shares of leveraged investment vehicles, including a determination as to whether there is "reasonable basis" to believe that a retail customer or client can assess the risks associated with these products. The proposal would also amend ICA Rule 6c-11 to permit certain leveraged or inverse ETFs to operate without receiving an exemptive order.
Additionally, the proposal would amend Forms N-PORT, N-LIQUID and N-CEN to require funds to provide certain information regarding (i) the fund's derivatives exposure and (ii) VaR and VaR test breaches.
Comments on the proposal must be submitted within 60 days after publication in the Federal Register.
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