SEC Proposes Significant New Restrictions on the Use of Derivatives and Other Transactions by Registered Funds and BDCs

December 30, 2015

The U.S. Securities and Exchange Commission (Commission) on December 11, 2015 proposed new Rule 18f-4 (Proposed Rule) under the Investment Company Act of 1940 (1940 Act) and amendments to certain proposed forms. The proposal relates to the use of derivatives and other transactions by registered investment companies – open-end funds, including exchange-traded funds (ETFs), and closed-end funds – and business development companies (BDCs) (collectively, funds).

The Proposed Rule would provide exemptive relief to “permit a fund to enter into derivatives and certain financial commitment transactions, notwithstanding the prohibitions and restrictions on the issuance of senior securities under Section 18 of the [1940 Act],” subject to various conditions. If the Proposed Rule is adopted, subsequent to the transition period, funds could only enter into “derivatives transactions” and “financial commitment transactions” in accordance with the requirements of the Proposed Rule or Sections 18 (or 61 in the case of BDCs) of the 1940 Act.

The conditions applicable under the Proposed Rule would include:

  • Alternative 150% and 300% leverage-based portfolio limitations for funds that utilize derivatives;
  • Uniform asset segregation requirements for derivatives and financial commitment transactions; and
  • Board-approved procedures and derivatives risk management program requirements.

This Dechert OnPoint summarizes the conditions under the Proposed Rule and highlights important issues that may be raised by this proposal.

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