Mutual funds may soon report not just to the Securities and Exchange Commission but the Commodity Futures Trading Commission as well, in some circumstances.
And answering to the two regulators will be problematic, because their requirements are “at once duplicative and fundamentally inconsistent,’’ according to ICI general counsel Karrie McMillan.
The CFTC voted in February to amend Rules 4.13 and 4.5 of Title 17 of the Code of Federal Regulations to make it significantly harder for mutual funds to avoid its purview. For instance, mutual funds now must register as commodity pool operators if they trade more than 5% of their liquidated asset value in speculative commodities trading.
“Funds’ use of derivatives brings enormous benefits to fund investors,’’ McMillan will point out Monday morning at the 2012 ICI Mutual Funds and Investment Management Conference in Phoenix .
Mutual funds use options, futures, swaps, and other derivatives to provide exposure to the commodity markets “for those shareholders who seek that diversification,’’ she will argue in her opening address. “But they also use financial derivatives to efficiently manage their portfolios—hedging currency or credit risks, fine-tuning bond portfolios, and gaining access to asset classes that are too difficult or costly to trade directly.’’
This has been allowed for the last eight years, under the 4.5 exclusion.
But in January 2011, the CFTC rein in “futures-only investment products” that appeared to be evading or avoiding CFTC regulation.
Eliminating the 4.5 exclusion will mean that thousands of equity, bond, and hybrid mutual funds will “have a brand new regulator with sweeping powers,’’ even though they aren’t “futures-only investments.’’
The Dodd-Frank Wall Street Refrom Act “didn’t call on the agency to re-examine 4.5—and the CFTC has never demonstrated why the amendments are necessary now,’’ an advance copy of her speech notes. “But the agency piled 4.5 on top of its allegedly crushing workload anyway—because, in their words, the amendments are “consistent with the tenor” of Dodd-Frank.
Which swaps will fall under CFTC regulation or how funds’ use of these swaps will be affected also is not clear, yet, she will say. Yet adverisers to many funds that use swaps will be forced to register with the CFTC.
She will note that a CFTC commissioner has already indicated the cost-benefit analysis is “sorely lacking” on this change.
And she will content that the CFTC is taking advantage of the turmoil after passage of the Dodd-Frank Act, to make “ a regulatory land grab.’
“ The result will either vastly expand the CFTC’s jurisdiction—or drive mutual funds out of the markets for futures, options, and swaps. Either way, investors lose,’’ she will say, in sum.
The commodities sector has seen an explosion in mutual fund activity, according to statistics prepared for a Jan. 26 hearing held by the Senate Permanent Subcommittee on Investigations. In 2011, there were at least 40 mutual funds investing over $55 billion in the commodities market. In 2008, there were five funds with less than $10 billion in assets placed in commodities-related financial instruments.
According to exhibits prepared for that hearing, managers include some of the biggest names in the industry, such as the Pacific Investment Management Company, which has nearly $25 billion in the sector and Fidelity Investments with more than $7 billion.
Other big names cited include OppenheimerFunds, Goldman Sachs Group, Credit Suisse and BlackRock.
Niche players include Equinox Fund Management and AQR Capital Management.
None of these companies are the subject of any federal investigations or enforcement actions, nor have they been accused of any wrongdoing, related to this issue.