SEC Derivative Reform Could Influence Mutual Fund Use

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NEW YORK--(BUSINESS WIRE)-- Tighter Securities and Exchange Commission (SEC) restrictions regarding the use of derivatives by mutual funds could influence the way asset management firms manage portfolio risk and report fund exposures.

We believe derivatives can be an effective tool for mutual funds to manage existing risks and/or take on new risk exposures. But use of the securities also has the potential to introduce counterparty, liquidity, and concentration risks, all of which need to be effectively managed and reported.

Proposed rules changes from the SEC could require increased transparency of derivatives usage by funds, which should be positive for fund investors. With that said, the regulation may also influence funds' access to derivatives as investment and risk management tools.

Fitch evaluates the use of derivatives by a wide range of fund types including money market mutual funds, where derivative use is extremely limited, and closed-end funds (CEFs) where derivative use is more widespread for both hedging and speculative purposes. In all cases, Fitch seeks to understand the strategic purpose of any derivatives the fund is employing in order to capture the risks (or benefits) in its analysis.

For example, for CEFs Fitch specifically captures any economic leverage and concentration risk created by derivatives in its CEF ratings. As noted in a recent report, 88 of the 121 U.S. CEFs rated by Fitch utilized some sort of derivative as of Sept. 30, 2011. Speculative purposes included long positions in credit default swaps (CDS), which allow funds to synthetically assume the credit risk of corporate bonds and indexes.

In August, the SEC published a concept release and request for comment on restructuring regulatory framework regarding the use of derivatives via mutual funds. Last week, the SEC received letters from some large asset management firms urging it to recognize the important part derivatives can play in effectively managing portfolios. The public comment period closed on Nov. 10, 2011 and the SEC is determining when and if new rules should be imposed.

RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

For more information of Fitch's evaluation of derivative exposure in CEFs, please see the special report entitled "Closed-End Funds: Derivatives Under Review" dated Nov. 16, 2011. Additional information is available on www.fitchratings.com.

Applicable Criteria and Related Research:

Closed-End Funds: Derivatives Under Review (Increased Use and Limited Transparency Are Key Considerations)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=656591

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.

Fitch RatingsKellie Geressy-Nilsen, +1-212-908-9123Senior DirectorFitchWireFitch, Inc.One State Street PlazaNew York, NY 10004orRoger Merritt, +1-212-908-0636Managing DirectororNathan Flanders, +1-212-908-1827Managing DirectororMedia Relations:Brian Bertsch, +1-212-908-0549Email: [email protected]

Source: Fitch Ratings

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