SEC Floats Rule to Rein In Funds’ Use of Derivatives

The SEC rule would also require a fund to segregate assets equal to the amount that the fund would pay if the fund exited the derivatives transaction at the time of the determination, and to also segregate an additional risk-based coverage amount representing a reasonable estimate of the potential amount the fund would pay if the fund exited the derivatives transaction under stressed conditions. SEC Commissioner Luis Aguilar, who will be leaving his post by the end of the month, stated at the meeting that as "demonstrated by the 2008 financial crisis, and the economic turmoil that followed, years of regulatory complacency and deregulation enabled an unregulated derivatives marketplace to cause significant losses to investors."

He noted that the global derivatives market "remains huge, at an amount estimated in excess of $630 trillion in notional value worldwide," with a "notable growth in the use of derivatives by registered investment companies." That growth, he continued, "is particularly remarkable with alternative strategy funds, which tend to use derivatives in the hope of achieving higher returns."

In 2010, Aguilar said, there were only about 590 alternative strategy funds, with around $320 billion in assets under management. By the end of 2014, however, there were more than 1,100 such funds, with total assets under management in excess of $469 billion.

Paul Schott Stevens, president and CEO of the Investment Company Institute, said after the rule plan was put out for comment that funds' use of derivatives "is governed by the vital safeguards of the Investment Company Act of 1940, which ensure transparency and disclosure to shareholders," and that while ICI welcomes the SEC's examination of these rules, the "proposal is complex and it will take the fund industry some time to fully assess its breadth and implications."

— Check out Bill Gross Doesn't Let SEC Guidelines Stop Big Bond Bets on ThinkAdvisor.