SEC reviews funds' derivatives use

[March 26, 2010]  WASHINGTON (AP) -- The Securities and Exchange Commission is reviewing the use of financial derivatives by mutual funds, exchange-traded funds and other investments to determine whether new protections are needed for investors.

The SEC said Thursday that while the review by its staff is ongoing, the agency won't approve any new exchange-traded funds that would make "significant investments" in derivatives. Existing ETFs and other types of funds won't be affected.

Derivatives, the complex instruments traded in a $600 trillion global market and blamed for playing a role in the financial crisis, have come under heightened scrutiny in the U.S. and Europe. Particular attention is being focused on credit default swaps, a form of insurance against loan defaults, which account for about 10 percent of the derivatives market.

SEC Chairman Mary Schapiro has called for Congress to impose new oversight on derivatives, warning that allowing risky instruments like the swaps to continue unfettered could bring further economic damage. Federal regulation of the derivatives market is included in sweeping legislation to overhaul financial regulation that passed the House in December and also is included in a new Senate bill.

"Although the use of derivatives by funds is not a new phenomenon, we want to be sure our regulatory protections keep up with the increasing complexity of these instruments and how they are used by fund managers," Andrew Donohue, director of the SEC's investment management division, said in a statement. "This is the right time to take a step back and rethink those protections."

The SEC review will examine, among other things, whether funds' use of derivatives is consistent with rules for concentration of assets and risk management, and whether fund directors are adequately overseeing their use.

Exchange-traded funds trade like stocks but mirror other assets such as stock indexes or commodities. Unlike traditional mutual funds, ETF shares can be traded throughout the day.

Conventional ETFs track a market index such as the Standard & Poor's 500. So-called leveraged ETFs seek to deliver multiples of an index or benchmark, often in volatile areas like commodities or currencies that involve derivatives.

[Associated Press]

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