Conformed to Federal Register version SECURITIES AND ...

1 Conformed to Federal Register version SECURITIES AND EXCHANGE COMMISSION 17 CFR Parts 239, 249, 270, and 274 [Release No. IC-34084; File No. S7-24-15] RIN 3235-AL60 Use of Derivatives by Registered Investment Companies and Business Development Companies AGENCY: SECURITIES and Exchange Commission. ACTION: Final rule. SUMMARY: The SECURITIES and Exchange Commission (the Commission ) is adopting a new exemptive rule under the Investment Company Act of 1940 (the Investment Company Act ) designed to address the investor protection purposes and concerns underlying section 18 of the Act and to provide an updated and more comprehensive approach to the regulation of funds use of derivatives and the other transactions the new rule addresses. In addition, the Commission is adopting new reporting requirements designed to enhance the Commission s ability to effectively oversee funds use of and compliance with the new rule, and to provide the Commission and the public additional information regarding funds use of derivatives.

2 Finally, the Commissio n is adopting amendments under the Investment Company Act to allow leveraged/inverse ETFs that satisfy the rule s conditions to operate without the expense and delay of obtaining an exemptive order. The Commission, accordingly, is rescinding certain exemptive relief that has been granted to these funds and their sponsors. DATES: Effective Date: This rule is effective February 19, 2021. Compliance Date: August 19, 2022. See Section of the Supplementary Information. FOR FURTHER INFORMATION CONTACT: Blair Burnett, Senior Counsel; Joel Cavanaugh, Senior Counsel; Mykaila DeLesDernier, Senior Counsel, John Lee, Senior Counsel; Amy Miller, Senior Counsel; Amanda Hollander Wagner, Branch Chief; Thoreau A. Bartmann, Senior Special Counsel; or Brian McLaughlin Johnson, Assistant Director, at (202) 551-6792, 2 Investment Company Regulation Office, Division of Investment Management; Securit ies and Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090.

3 SUPPLEMENTARY INFORMATION: Regulat ions in 17 CFR ( rule 18f-4 ) will apply to mutual funds (other than money market funds), exchange-traded funds ( ETFs ), registered closed-end funds, and companies that have elected to be treated as business development companies ( BDCs ) under the Investment Company Act (collectively, funds ). It will permit these funds to enter into derivatives transactions and certain other transactions, notwithstanding the restrictions under sections 18 and 61 of the Investment Company Act, provided that the funds comply with the conditions of the rule. The rule also permits mo ney market funds (and other funds) to invest in SECURITIES on a when-issued or forward-settling basis, or with a non-standard settlement cycle, subject to conditions. The Commission is adopting rule 18f-4 under the Investment Company Act, amendments to 17 CFR (rule 6c-11), 17 CFR (rule 22e-4), and 17 CFR (rule 30b1-10) under the Investment Company Act; amendments to Form N-PORT [referenced in 17 CFR ], Form N-LIQUID (which we are re-titling as Form N-RN ) [referenced in 17 CFR ], Form N-CEN [referenced in 17 CFR ], and Form N-2 [referenced in 17 CFR ] under the Investment Company Act.

4 TABLE OF CONTENTS I. Introduction .. 6 A. Overview of Funds Use of Derivatives .. 10 B. Derivatives and the Senior SECURITIES Restrictions of the Investment Company Act .. 14 1. Requirements of Section 18 .. 14 2. Investment Company Act Release 10666 and the Status of Derivatives Under Section 18 .. 16 3. Need for Updated Regulatory framework .. 24 C. Overview of the Final Rule .. 27 II. 34 A. Scope of Rule 18f-4 .. 34 B. Derivatives Risk Management Program .. 46 1. Program Administration .. 49 2. Required Elements of the Program .. 58 C. Board Oversight and 75 3 1. Board Approval of the Derivatives Risk Manager .. 78 2. Board Reporting .. 80 D. Limit on Fund Leverage Risk .. 87 1. Use of VaR .. 88 2. Relative VaR Test .. 96 3. Absolute VaR Test .. 124 4. Funds Limited to Certain Investors .. 128 5. Choice of Model and Parameters for VaR Test.

5 130 6. Implementation .. 140 E. Limited Derivatives Users .. 149 1. Derivatives Exposure .. 150 2. Limited Derivatives User 153 3. Risk Management .. 166 4. Exceedances of the Limited Derivatives User Exception .. 168 F. Approach to Leveraged/Inverse Funds .. 173 1. Proposed Alternative Requirements for Leveraged/Inverse Funds .. 173 2. Treatment of Leveraged/Inverse Funds Under Rule 18f-4 .. 182 3. Standards of Conduct for Broker-Dealers and Registered Investment Advisers .. 184 4. Staff Review of Regulatory Requirements Relating to Complex Financial Products .. 187 5. Treatment of Existing Leveraged/Inverse Funds that Seek to Provide Leveraged or Inverse Market Exposure Exceeding 200% of the Return of the Relevant 188 6. Amendments to Rule 6c-11 under the Investment Company Act and Proposed Rescission of Exemptive Relief for Leveraged/Inverse ETFs.

6 191 G. Amendments to Fund Reporting Requirements .. 193 1. Amendments to Form 195 2. Amendments to Current Reporting Requirements .. 205 3. Amendments to Form N-CEN .. 211 H. Reverse Repurchase Agreements .. 213 I. Unfunded Commitment Agreements .. 224 J. Recordkeeping Provisions .. 230 K. Conforming Amendments .. 233 1. Form N-PORT and Rule 233 2. Form N-2 (Senior SECURITIES Table) .. 234 L. Compliance Date .. 236 M. Other Matters .. 238 III. Economic Analysis .. 238 A. Introduction .. 238 B. Economic Baseline .. 242 1. Fund Industry Overview .. 242 2. Funds Use of Derivatives and Reverse Repurchase Agreements .. 243 3. Current Regulatory framework for 244 4. Funds Derivatives Risk Management Practices and Use of VaR Models .. 245 5. Leveraged/Inverse Funds .. 246 4 C. Benefits and Costs of the Final Rules and Amendments.

7 247 1. Derivatives Risk Management Program and Board Oversight and Reporting .. 248 2. VaR-Based Limit on Fund Leverage Risk .. 256 3. Limited Derivatives 268 4. Reverse Repurchase Agreements and Similar Financing Transactions .. 271 5. Treatment of Existing Leveraged/Inverse Funds that Seek to Provide Leveraged or Inverse Market Exposure Exceeding 200% of the Return of the Relevant Index .. 274 6. Amendments to Rule 6c-11 under the Investment Company Act and Rescission of Exemptive Relief for Leveraged/Inverse ETFs .. 276 7. Unfunded Commitment Agreements .. 278 8. Recordkeeping .. 279 9. Amendments to Fund Reporting Requirements .. 282 10. When-Issued and Forward-Settling 286 D. Effects on Efficiency, Competition, and Capital Format ion .. 287 1. Efficiency .. 287 2. Compet it ion .. 291 3. Capital Format ion .. 293 E. Reasonable Alternatives.

8 294 1. Alternative Implementations of the VaR Tests .. 294 2. Alternatives to the VaR Tests .. 300 3. Stress Testing Frequency .. 304 4. Enhanced Disclosure .. 305 5. Alternative Treatment for Leveraged/Inverse Funds .. 306 IV. Paperwork Reduction Act Analysis .. 310 A. Introduction .. 310 B. Rule 18f-4 .. 311 1. Derivatives Risk Management Program .. 314 2. Board Oversight and Reporting .. 316 3. VaR Remediation .. 318 4. Disclosure Requirement for Certain Leveraged/Inverse Funds .. 320 5. Disclosure Changes for Money Market Funds .. 322 6. Requirements for Limited Derivatives Users .. 324 7. Recordkeeping 328 8. Rule 18f-4 Total Estimated Burden .. 334 C. Rule 6c-11 .. 335 D. Form N-PORT .. 339 E. Form N-RN and Rule 30b1-10 .. 344 F. Form N-CEN .. 347 V. Final Regulatory Flexibility Analysis .. 350 A. Need for and Objectives of the Rule and Form Amendments.

9 350 B. Significant Issues Raised by Public Comments .. 351 C. Small Entit ies Subject to the Final Rule .. 354 D. Projected Reporting, Recordkeeping, and Other Compliance Requirements .. 354 1. Rule 18f-4 .. 354 5 2. Amendments to Forms N-PORT, N-RN, and 366 3. Amendments to Rule 6c-11 .. 370 E. Agency Action to Minimize Effect on Small Entities .. 371 1. Alternative Approaches to Rule 18f-4 .. 372 2. Alternative Approaches to Amendments to Forms N-PORT, N-LIQUID (N-RN), and N-CEN .. 375 3. Alternative Approaches to Rule 6c-11 .. 376 VI. statutory Authority .. 377 6 I. INTRODUCTION The Commission is adopting rule 18f-4 under the Investment Company Act to provide an updated, comprehensive approach to the regulation of funds use of derivatives. This rule, along with amendments that the Commission is adopting to rule 6c-11 and certain forms under the Investment Company Act, will modernize the regulatory framework for funds to reflect the broad ways in which funds use of derivatives has developed over past decades, and also will address investor protection concerns related to funds derivatives use.

10 We are committed to designing regulatory programs that reflect the ever-broadening product innovation and investor choice available in today s asset management industry, while also taking into account the risks associated with funds increasingly complex portfolio composition and operations. The rules we are adopting reflect these considerations, and are also informed by the Commission s ongoing exploration particularly over the past decade of the benefits, risks, and costs associated with funds current practices regarding Under this new framework , funds using derivatives generally will have to adopt a derivatives risk management program that a derivatives risk manager administers and that the fund s board of directors oversees, and comply with an outer limit on fund leverage risk based on value at risk, or VaR. Funds that use derivatives only in a limited manner will not be subject to these requirements, but they will have to adopt and implement policies and procedures 1 See, , Use of Derivatives by Investment Companies under the Investment Company Act of 1940, Investment Company Act Release No.