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Another Wall Street Give-a-way Endangering Investors

A provision tucked into the spending bill this week illustrates so much of what’s wrong with the current wave of financial de-regulation we’re witnessing.  It means more risk for everyday investors, regulatory relief for a financial sector that doesn’t need it, and a policy-making process that’s hidden in the shadows—all with an outcome that experts oppose and that threatens investors.       

The provision would allow a type of investment company known as a “Business Development Company” or “BDC” not just to increase but to double its leverage ratio, or the amount of debt it can assume.  Unfortunately, more leverage means more risk to investors, and that’s especially worrisome for two reasons.  First, BDCs were created for the purpose of assisting small to medium-sized operating companies that are already struggling or at the margins when it comes to raising capital.  So BDC portfolios already have plenty of risk built in.  Second, unlike venture capital or private equity funds, BDCs are publicly-traded and therefore allow all investors, not just the wealthy or financially sophisticated, to put their money at risk.  Allowing BDCs to double their leverage is a huge increase that layers significantly more risk into the investment, to the peril of investors who may be ill-equipped to absorb the losses. 

And just as Wall Street has clamored for regulatory relief even though banks are setting records for their loan volumes, revenues, and profits, the BDCs have fought for this change even though they have been doing extraordinarily well over the last decade.   The BDC industry is growing rapidly.  Since the 2008 financial crisis, net assets for BDCs have increased six-fold, from $9 billion to $55 billion.  This loosening of the leverage limit simply isn’t necessary to foster economic growth or boost a struggling financial sector.  It will, however, increase the profits for BDC managers.

Finally, and just as troubling as the merits, is the process.  This provision in the spending bill was among a number of de-regulatory measures debated on the Hill and elsewhere over the last two years, in the light of day.  It rightly drew criticism.  Better Markets testified  against it during Senate subcommittee hearings, and SEC Chair Mary Jo White voiced strong opposition, singling out the increased leverage provision as especially unwise.  As she explained in her letter to members of Congress, “the proposed increase in leverage for BDCs gives rise to significant investor protection concerns, concerns which are heightened because most BDC shareholders are retail investors.” 

So how did it manage to survive?  The answer is clear:  It had to be tucked into a must-pass spending bill while attention was focused on keeping the government open, not on what’s best for our investors and markets.

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