My previous post tried to explain how Rule 2a-7 limits the “leveraging effects” of “firm commitments” made by money market funds. This post will add some important qualifications, compare the approach taken by Rule 2a-7 to the proposed approach in Rule 18f-4 and discuss the need to reconcile these rules. Continue Reading What Rule 2a-7 Tells Us about Re-Proposed Rule 18f-4
This post continues my consideration of why certain “unfunded commitment agreements” should be carved out of the valuation at risk limitations of re-proposed Rule 18f-4. My previous post explained why two of the justifications offered for this carve out do not bear scrutiny. My current view is that the scope of the carve out depends on the third proposed justification: that some commitments may not have “leveraging effects.” This requires an understanding of the leveraging effects regulated by Section 18 of the Investment Company Act.
I will use the example of money market funds to explore “leveraging effects” because (a) it allows me to answer a question raised in the proposing release and (b) it illustrates another means of limiting leverage. Continue Reading Money Market Funds and Re-Proposed Rule 18f-4
This post continues my assessment of the proposed treatment of unfunded commitments under re-proposed Rule 18f-4. My previous post questioned whether the proposed definition of an “unfunded commitment agreement” successfully carved these transactions out of the definition of “derivatives transactions.” This post begins my evaluation of why such a carve out may be warranted.
The SEC’s release cites three factors offered by commenters that the SEC agreed “distinguish unfunded commitment agreements from … derivatives transactions.” Unfortunately, the first two of these factors do not provide a sound basis for drawing such a distinction. Continue Reading Re-Proposed Rule 18f-4: How Not to Distinguish Commitments from Derivatives
My initial posts on re-proposed Rule 18f-4 reflect my generally favorable reactions to the SEC’s attempt to develop a practical, hence imperfect, means of implementing the limitations on senior securities required by Section 18 of the Investment Company Act of 1940. My initial series of post written at the time Rule 18f-4 was first proposed attempted to explain some of the inherent difficulties of this task.
I will now turn to a more problematic matter: the proposed treatment of so-called “unfunded commitment agreements.” While I basically agree with the proposed approach of limiting commitments by requiring a reasonable means of meeting the fund’s obligations, I have reservations about how and why the rule proposes to implement this approach. Continue Reading Does Re-Proposed Rule 18f-4 Have Commitment Issues?
The publication of the SEC’s re-proposed rules for regulating the use of derivatives by investment companies in the Federal Register provides an opportunity to continue our consideration of this proposal. The publication fixes the deadline for comments at March 24, 2020. The proposed classifications of how funds may use derivatives, the taxonomy of these funds if you will, provides a useful starting place for organizing our consideration of re-proposed Rule 18f-4. Continue Reading Re-Proposed Rule 18f-4—Fund Taxonomy
In my initial post on the SEC’s reproposed rules for regulating the use of derivatives by investment companies (“funds”), I noted favorably that the regulations would extend beyond funds to registered broker/dealers and investment advisers. I think this reflects a more comprehensive, less piecemeal, approach to these proposed rules. I also appreciate the coordination of the Divisions of Investment Management and Trading and Markets in drafting the proposed rules.
There are other praiseworthy aspects of the general approach taken in developing the revised proposals. Chief among these is the SEC’s willingness to take a fresh look at the means of regulating the risks of derivatives usage. Historically, the SEC’s principal means for regulating these risks was to require funds to “segregate” liquid assets to cover a fund’s potential obligations for derivative transactions. The revised proposals would eliminate asset segregation in favor of more direct limits on potential volatility resulting from derivative transactions. Risks posed by payment or delivery obligations would represent just one, no longer paramount, component of a comprehensive risk management program.
We previously explored the treatment of “leveraged/inverse investment vehicles” under SEC’s reproposal for regulating how funds use derivatives in compliance with Section 18 of the Investment Company Act of 1940 (proposed Rule 18f-4), and related proposed Rule 15l-2 under the Securities and Exchange Act of 1934 and Rule 211h-1 under the Investment Advisers Act of 1940. In this post we consider the options available to retail investors for leveraged trading and whether a more consistent approach may make sense.
We are still digesting the SEC’s reproposal for regulating how mutual funds, ETFs, closed-end funds and BDCs (“funds”) may use derivatives in compliance with Section 18 of the Investment Company Act of 1940 (proposed Rule 18f-4), but one surprising aspect is proposed Rule 15l-2 under the Securities Exchange Act of 1934. As explained more fully below, Rule 15l-2 would increase the due diligence required before a broker/dealer permits a customer to trade in “leveraged/inverse investment vehicles.” Including this rule in the proposal required the cooperation of both the Trading and Markets and Investment Management Divisions of the SEC. There is even a parallel rule proposed for investment advisers (proposed Rule 211h‑1). This shows that the SEC is taking a more comprehensive view of the SEC’s authority over the use of leverage in securities trading.
Although we find this non-compartmentalized approach heartening, we think that more could be done to fully deploy the SEC’s powers in this area. We even dare to suggest that, having avoided silos within itself, the SEC might try to work with the Fed to better rationalize regulation of leverage in the financial system.
In an earlier post, I noted that Release No. IC-10666 was issued before interest rate swaps were invented. This may have been unfortunate, because swaps present unique challenges to Release 10666’s approach to asset segregation. I believe that difficulty with applying Release 10666 to swaps has contributed to inconsistency in the segregation requirements for different derivatives.
Swaps: The Revenge of Middle School Algebra Continue Reading Release 10666 and the Problem of Swaps
I’ve been discussing comments on the SEC’s proposed Rule 18f-4 in light of the SEC’s initial regulation of derivatives in Release No. IC-10666 (“Release 10666”). As explained in my first post, the objectives of the proposed rule include limiting the “speculative character” of funds that use derivatives and assuring they have sufficient assets to cover their obligations. Release 10666 used one means, asset segregation, to achieve both ends. Several comment letters appear to question whether this approach is still tenable. Continue Reading Should Asset Segregation Do Double Duty?