Analysis of SEC’s Proposal to Update the Regulation of Funds’ Use of Derivatives and Other Transactions

The U.S. Securities and Exchange Commission on November 25, 2019 unanimously approved for publication a three-part rule proposal related to the use of derivatives and certain other transactions by registered investment companies (i.e., open-end funds other than money market funds; closed-end funds; and exchange-traded funds) and business development companies (collectively, funds). The proposal includes: (1) new Rule 18f‑4 under the Investment Company Act of 1940 (Proposed Rule); (2) new rules relating to leveraged/inverse funds and vehicles, including sales practices rules under the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 and a related amendment to Rule 6c-11 under the 1940 Act; and (3) related fund reporting form amendments and recordkeeping requirements.

The Proposed Rule is a re-proposal of a 2015 Commission rulemaking effort that would have permitted a fund to enter into derivatives transactions and “financial commitment transactions” subject to certain conditions. The 2015 Proposed Rule was the first significant Commission or staff action relating to funds’ use of derivatives since the Commission’s issuance of a concept release on funds’ use of derivatives in 2011.

The proposal would rescind Release 10666 and the related “asset segregation” requirements articulated in that release, and the Commission staff may also withdraw related no-action letters and other guidance. As a result, a fund would need to comply with the conditions set forth in the Proposed Rule in order to engage in the applicable transactions or otherwise comply with Section 18 of the 1940 Act.

Further, while presented as an “exemptive” rule, the Proposed Rule would place restrictions on the manner in which many funds currently use derivatives based on existing Commission and no-action guidance. Similar to the 2015 Proposed Rule, if adopted, the Proposed Rule and the related items would represent the most significant change to the way the Commission regulates funds’ use of derivatives and the obligations of fund boards since the time that Release 10666 was published.

The Commission requests comment on all aspects of the Proposed Rule and related items. This OnPoint provides a detailed overview of the Proposed Rule and Proposing Release and highlights certain notable requests for comment. The Proposing Release states that comments should be submitted on or before 60 days following the publication of the Proposing Release in the Federal Register. As of the date of publication of this OnPoint, the Proposing Release has not been published in the Federal Register.

Read full version of "Analysis of SEC’s Proposal to Update the Regulation of Funds’ Use of Derivatives and Other Transactions (58 pages)."

Authored by Philip Hinkle, Audrey Wagner, Susan Grafton, Mark Perlow, Jonathan Massey, Ashley Rodriguez and Nadeea Zakaria.

Co-authored by Phil Garber, Marylyn Harrell, Sam Scarritt-Selman, Katie Shorey, Aiman Tariq and Nick Ward with contributions from Aaron Withrow, Colman O’Loghlen and Radin Ahmadian.