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Serious Flaws Remain in the SEC’s Framework Governing Derivatives-related Risks in Mutual Funds

FOR IMMEDIATE RELEASE
Wednesday, October 28, 2020
Contact: Pam Russell at prussell@bettermarkets.com
 
Washington, D.C.  –  Joseph R. Cisewski, Senior Derivatives Consultant and Special Counsel for Better Markets, issued the following statement regarding the Securities and Exchange Commission’s (SEC) finalization of a new framework governing derivatives use by certain registered funds:
 
The 2008 financial crisis demonstrated that unregulated and under-regulated derivatives activities by a relatively small number of people and institutions on Wall Street can lead to economic catastrophe for all of America’s working families. Remarkably, despite the central role derivatives played in causing that meltdown, the SEC never implemented a comprehensive regulatory framework to rein in derivatives use by mutual funds. 
 
“This morning, the SEC took modest steps forward by finalizing regulations setting forth risk management, governance, and leverage requirements for mutual funds employing derivatives in their investment strategies. This entirely new regulatory framework has some merit. It does not amend an existing regulatory framework but instead replaces dozens of SEC staff opinions and other informal actions dating back to the 1970s when derivatives markets, practices, and risks were markedly different. 
 
“Yet, undeniably, the SEC missed an opportunity to enact meaningful constraints on derivatives-related leverage in mutual funds. For example, the SEC’s overreliance on value-at-risk (VaR) measures will not fully address leverage concerns or derivatives risks (as we revealed in our comment letter). Furthermore, judging from an SEC commissioner’s statement in this morning’s meeting, the finalized VaR measures may have been calibrated specifically to avoid limiting leverage and derivatives risks in mutual funds. The SEC may have built an elaborate derivatives framework designed to give the appearance of taking meaningful action without actually doing so. 
 
“The SEC should have taken steps, at the very minimum, to supplement its VaR framework with other leverage constraints. VaR models have a long history of failing precisely when market risk management matters the most. In fact, market risk model failures and limitations are widely acknowledged to have contributed to precipitous losses before, during, and after the 2008 financial crisis.  Even with recent regulatory attention to model risk management, VaR models continue to have limitations. They are not suited or designed to address numerous risks—including tail risks—relevant to mutual funds responsible for trillions of dollars of working Americans’ retirement savings.
 
“The SEC eventually will have to go back to the drawing board. We just hope that the retirement savings of working families is not adversely impacted before that happens.”
 
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Better Markets is a non-profit, non-partisan, and independent organization founded in the wake of the 2008 financial crisis to promote the public interest in the financial markets, support the financial reform of Wall Street and make our financial system work for all Americans again. Better Markets works with allies – including many in finance – to promote pro-market, pro-business and pro-growth policies that help build a stronger, safer financial system that protects and promotes Americans’ jobs, savings, retirements and more. To learn more, visit www.bettermarkets.com.

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