Yesterday, the Securities and Exchange Commission adopted final rules relating to the use of derivatives by registered investment companies and business development companies.

The use of derivatives by funds has been the subject of consideration for some time now. The current regulatory framework is outdated and depends on an SEC statement from 1979 and various no-action letters and guidance.

The SEC fact sheet notes that the Investment Company Act limits the ability of registered funds and business development companies to engage in transactions that involve potential future payment obligations, including obligations under derivatives such as forwards, futures, swaps and written options. The new rule permits funds to enter into these transactions if they comply with certain conditions designed to protect investors. These conditions include adopting a derivatives risk management program and complying with a limit on the amount of leverage-related risk that the fund may obtain based on value-at-risk, or “VaR.”

A streamlined set of requirements will apply for funds that use derivatives in a limited way. The rule also permits a fund to enter into reverse repurchase agreements and similar financing transactions, as well as “unfunded commitments” to make certain loans or investments, subject to conditions tailored to these transactions. Funds, including money market funds, will now be permitted under the rule to invest in securities on a forward-settling basis. Funds also will be subject to reporting and recordkeeping requirements regarding their derivatives use.

The new rule requirements also apply to leveraged or inverse ETFs, which have been the subject of regulatory concern. These were addressed in a separate statement on complex products issued jointly today, here.

The fact sheet is available here and the adopting rule is available here.

A client alert will follow.

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