Pending completion of a review to evaluate the use of derivatives by mutual funds, ETFs, and other investment companies, the SEC issued a release in March 2010 indicating that it will defer consideration of exemptive requests to permit ETFs that would make significant investments in derivatives. The deferral will affect new and pending requests from certain actively-managed and leveraged ETFs that rely on swaps and other derivative instruments to achieve their investment objectives, but will not affect any existing ETFs.
The SEC’s review is intended to explore issues related to the use of derivatives by mutual funds and ETFs 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; and,
- funds’ derivative activities should be subject to special reporting requirements
According to The Economist, the SEC intends to complete the review by the end of the summer, and says its goal is to craft a policy that will limit the use of derivatives by ETFs.
FAIR Canada urges Canadian securities regulators to similarly turn their attention to ETFs, with a particular focus on the marketing and advertising practices used by firms selling their products to retail investors.