Securities and Exchange Commission Tackles Fund Use of Derivatives


On August 31, 2011, the Securities and Exchange Commission (the “Commission”) published a Concept Release and requested comments on issues concerning the use of derivatives by investment companies, including mutual funds, closed-end funds, exchange-traded funds and business development companies. These issues include, among other things, the potential implications for fund leverage, diversification, exposure to certain securities-related issuers, portfolio concentration, and valuation.

Although the Concept Release makes few specific proposals, it lays the groundwork for future action that could change the regulatory landscape affecting funds that use derivatives. Depending on which direction the Commission takes, these changes could have wide-ranging implications for investment advisers, funds, and independent fund directors.

The Concept Release summarizes how funds currently use derivatives and issues that flow from their increased usage.

Funds use derivatives for a variety of purposes, including to leverage and to boost returns, gain access to certain markets or reference assets, achieve greater transaction efficiency, and hedge interest rates, credit, and other risks. Derivatives usage gives rise to concerns about risk management, especially in areas involving leverage, illiquidity, and counterparty risk.

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