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SEC Proposes New Regulation Limiting Funds’ Use of Derivatives

In a continued effort to tighten investment transparency and reign in market impacts of more exotic investment tools, the Securities Exchange Commission announced it would be seeking increased regulatory oversight on derivatives and how they are used by all types of investment institutions, including mutual funds, close-end funds, business development and even auto-directed tools such as exchange-traded funds. The primary goal is to reduce what is considered wild speculation activity that has high risk and essentially uses investor funds to make high-gamble moves on the market prone to big losses.

The SEC management sees the regulatory expansion as a means by which to put derivatives and their use by institutional holders under the same compliance and scrutiny as many other higher risk securities. The changes are expected to lead to an increase in monitoring and risk awareness in investors.

Currently, derivatives fall under the Investment Company Act. That law specifies limitations on how individual investors can use and take positions on the market with forwards, futures, swaps and options. The new regulations would allow mutual funds to take advantage of these funds if their management complies with specific criteria in terms of paperwork, notice, education and practices. For example, limitations on how much leverage could be used by a fund in total would come into play, as a fund manager in theory could make far bigger position plays with the dollar amount of an entire fund than an individual alone could. Another criteria would insure that a fund manager maintains a solvency level in the fund, and that he puts aside enough assets to meet the funds obligations, even when the market is in a downturn. This alone will have a significant reduction in how much leverage with which a fund manager could theoretically work.

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