SEC Adopts New Rules and Amendments to Update the Approach to the Regulation of Registered Funds’ and BDCs’ Use of Derivatives and Other Transactions

October 29, 2020

The following provides a brief overview of the Final Rule. For a more detailed anaylsis, please read Dechert’s comprehensive white paper.

The U.S. Securities and Exchange Commission on October 28, 2020 approved by a 3-2 vote a new rule and rule amendments (collectively, Final Rule) related to the use of derivatives and certain other transactions by registered investment companies (i.e., open-end funds other than money market funds (with a limited exception); exchange-traded funds; and closed-end funds) and business development companies (collectively, funds).

The Final Rule includes: (1) new Rule 18f‑4 under the Investment Company Act of 1940; (2) a related rule amendment under the 1940 Act pertaining to leveraged/inverse exchange-traded funds; (3) related fund reporting requirements and form amendments; and (4) a conforming amendment to Rule 22e-4 under the 1940 Act.

The Final Rule was proposed in November 2019 and was a re-proposal of a 2015 SEC rulemaking effort. The 2015 proposed rulemaking was the first significant SEC or staff action relating to funds’ use of derivatives and certain other transactions that create leverage since the SEC’s issuance of a Concept Release in 2011. Rule 18f-4 and the related items discussed in this OnPoint represent the most significant change to the way the SEC regulates funds’ use of derivatives and the other transactions and the obligations of fund boards since the seminal Release 10666 was published.

The Final Rule includes a number of significant changes to the 2019 Proposed Rule. The Adopting Release highlights that many of the changes to the Proposed Rule were made in response to industry comments and that certain changes take into account in particular commenters’ experiences in managing funds’ derivatives risk through the period of market volatility following the 2020 outbreak of the COVID-19 coronavirus across the world.

In view of the Final Rule, and consistent with the approach identified under the Proposed Rule, the SEC is rescinding Release 10666 and the related “asset segregation” requirements articulated in that release, after an 18-month transition period for funds to prepare to come into compliance with Rule 18f-4 following the effective date of the Final Rule, which will be 60 days after publication of the Final Rule in the Federal Register. The SEC staff also will withdraw related no-action letters and other guidance or portions thereof to the extent moot, superseded or otherwise inconsistent with the Final Rule. As a result, any fund will need to comply with the conditions set forth in the Final Rule in order to engage in the applicable transactions.

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