Memo #
32271

Draft ICI Comment Letter on SEC's Proposed Rules on Funds' Use of Derivatives and Sales Practices for Transactions in Leveraged/Inverse Investment Vehicles; Comments Requested by Monday, March 16
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[32271]

March 9, 2020 TO: 1940 Act Derivatives Working Group
Accounting/Treasurers Committee
Chief Compliance Officer Committee
Closed-End Investment Company Committee
Derivatives Markets Advisory Committee
ETF (Exchange-Traded Funds) Committee
Money Market Funds Advisory Committee
Operations Committee
Sales and Marketing Committee
SEC Rules Committee
Small Funds Committee
Variable Insurance Products Advisory Committee RE: Draft ICI Comment Letter on SEC's Proposed Rules on Funds' Use of Derivatives and Sales Practices for Transactions in Leveraged/Inverse Investment Vehicles; Comments Requested by Monday, March 16

 

As previously reported, the Securities and Exchange Commission recently proposed rules that would provide an updated approach to the regulation of derivatives and similar instruments used by mutual funds, exchange-traded funds, closed-end funds, and business development companies.[1] ICI’s draft comment letter responding to the proposal is attached for your review. 

Please provide any written comments to Ken Fang at kenneth.fang@ici.org by close of business on Monday, March 16.  Comments on the proposal are due to the SEC by March 24.

The draft comment letter strongly supports the Commission’s proposed rule on funds’ use of derivatives.  In addition, the comment letter makes several recommendations on the proposal, including: 

I. Proposed Rule 18f-4

Scope of Proposed Rule

  • Refine the definition of “derivatives transactions” to exclude forward settling firm and standby commitment agreements that have short settlement periods and create a fixed and known obligation.
  • Permit funds to invest in firm and standby commitments agreements under a modified asset segregation regime.
  • Permit money market funds to invest in firm and standby commitment agreements.

Leverage Limits

  • Clarify that the “designated reference index” under the proposed relative value-at-risk (“VaR”) test should reflect the fund’s investment strategies.
  • Provide additional guidance to derivatives risk managers to evaluate and make changes to designated reference indexes.
  • Permit an index fund that tracks an affiliated index to select the index as its designated reference index.
  • Increase the leverage limits for the proposed relative VaR test to 200 percent and the proposed absolute VaR test to 20 percent.
  • Increase the leverage limits for closed-end funds to reflect the increased leverage they can obtain through structural leverage.
  • Permit a fund to scale its VaR results from a 95 percent confidence level to a 99 percent confidence level.
  • Extend the period of a fund’s VaR test breach to five business days before requiring remedial action.
  • Eliminate the “timeout” restricting a fund from engaging in derivatives transactions (unless the derivatives are designed to reduce the fund’s VaR) immediately after a VaR test breach.

Program Requirements

  • Clarify the scope of stress testing correlations and permit a fund to conduct stress testing on a less frequent basis.
  • Permit a fund to conduct backtesting monthly for each day of the period.
  • Expand eligible derivatives risk managers to include a fund’s investment adviser and eliminate the requirement to have “relevant experience.”
  • Ensure that a fund’s board of directors performs a general oversight role over the derivatives risk management program.

Limited Derivatives User Exceptions

  • Include additional types of hedging and offsetting transactions within the “currency hedging exception.”
  • Clarify that differences of 10 percent or less of the value of hedged instruments would qualify as “negligible amounts.”
  • Combine the “currency hedging exception” with the “exposure-based exception” to exclude certain hedging and offsetting transactions permitted in the “currency hedging exception” from the “exposure-based exception” calculation.
  • Define the cure period for exceedances or breaches of the limited derivatives user exceptions.

Reverse Repurchase Agreements and Similar Financings

  • Permit funds to enter into reverse repurchase agreements and other similar financings under a modified asset segregation regime.
  • Permit funds to engage in securities lending activities consistent with the current framework. 

II. Public Reporting and Liquidity Rule Requirements

  • Do not require public disclosure of derivatives exposures and “VaR breaks,” because such information may be misleading and is neither necessary nor appropriate in the public interest.
  • Amend the liquidity rule, Form N-PORT, and related guidance consistent with final rules. 

III. Proposed Sales Practices Requirements

  • Subjecting certain registered investment companies to a different sales practice requirement than any other registered investment company is a novel and untested regulatory approach. Such an approach must be strongly justified with a demonstrated purpose and need, as registered funds are subject to a robust regulatory regime under the federal securities laws. 

IV. Compliance Dates 

  • Provide funds with a longer transition period under the new rules.

 

Kenneth Fang
Assistant General Counsel

Attachment

endnotes

[1] See Use of Derivatives by Registered Investment Companies and Business Development Companies; Required Due Diligence by Broker-Dealers and Registered Investment Advisers Regarding Retail Customers’ Transactions in Certain Leveraged/Inverse Investment Vehicles, Investment Company Act Release No. 33704 (Nov. 25, 2019), available at https://www.sec.gov/rules/proposed/2019/34-87607.pdf. For a summary of the proposal, see ICI Memorandum No. 32083, available at https://www.ici.org/my_ici/memorandum/memo32083.