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U.S. Securities and Exchange Commission

SEC Staff Evaluating the Use of Derivatives by Funds


Washington, D.C., March 25, 2010 — The SEC staff is conducting a review to evaluate the use of derivatives by mutual funds, exchange-traded funds (ETFs) and other investment companies. The review will examine whether and what additional protections are necessary for those funds under the Investment Company Act of 1940.

Pending the review's completion, the staff has determined to defer consideration of exemptive requests under the Investment Company Act to permit ETFs that would make significant investments in derivatives. The staff's decision will affect new and pending exemptive requests from certain actively-managed and leveraged ETFs that particularly rely on swaps and other derivative instruments to achieve their investment objectives. The deferral does not affect any existing ETFs or other types of fund applications.

"It's appropriate to engage in a more thorough review of the use of derivatives by ETFs and mutual funds given the questions surrounding the risks associated with the derivative instruments underlying many funds," said SEC Chairman Mary Schapiro.

"Although the use of derivatives by funds is not a new phenomenon, we want to be sure our regulatory protections keep up with the increasing complexity of these instruments and how they are used by fund managers," said Andrew Donohue, Director of the SEC's Division of Investment Management. "This is the right time to take a step back and rethink those protections."

The staff generally intends to explore issues related to the use of derivatives by funds, including, among other things, whether:

  • current market practices involving derivatives are consistent with the leverage, concentration and diversification provisions of the Investment Company Act

  • funds that rely substantially upon derivatives, particularly those that seek to provide leveraged returns, maintain and implement adequate risk management and other procedures in light of the nature and volume of the fund's derivatives transactions

  • fund boards of directors are providing appropriate oversight of the use of derivatives by funds

  • existing rules sufficiently address matters such as the proper procedure for a fund's pricing and liquidity determinations regarding its derivatives holdings

  • existing prospectus disclosures adequately address the particular risks created by derivatives

  • funds' derivative activities should be subject to special reporting requirements

The staff also will seek to determine what, if any, changes in Commission rules or guidance may be warranted.

Registered investment companies enable investors to purchase shares in a portfolio of securities. ETFs are similar to traditional mutual funds, and, like those funds, may seek to track an underlying benchmark or securities index or be actively managed. Unlike traditional mutual funds, shares of an ETF can be traded throughout the day on a securities exchange. In addition, "leveraged" ETFs are index-based ETFs that seek to deliver multiples or inverse multiples of the daily performance of the selected index using swaps and other derivatives.

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Modified: 03/25/2010