“Derivatives were at the core of igniting and spreading the catastrophic 2008 financial crash, but today, 12 years later, there is still no comprehensive regulation of the use of derivatives by mutual funds. Investors and markets deserve better, and the SEC’s re-proposed rulemaking is a step in the right direction. Nevertheless, the proposal has significant flaws that must be addressed as Better Markets outlines in its comment letter.

“The good news is that the SEC’s re-proposal establishes a number of sensible risk management, governance and leverage requirements designed to address investor protection and systemic risks associated with the use of derivatives by most registered open-end or closed-end funds and business development companies. The bad news is that the SEC’s overreliance on value-at-risk (VaR) measures would not fully address leverage concerns or derivatives risks at mutual funds.

“VaR models have a long history of failing precisely when market risk management matters the most. Indeed, market risk model failures and limitations are widely acknowledged to have contributed to precipitous losses before, during, and after the 2008 crash.  Moreover, VaR analysis too often has given false comfort to management, including senior personnel in risk management functions. Even with recent regulatory attention to model risk management, VaR models continue to have known, material limitations, and 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’ savings.

“For that reason, and the others we detail in our comment letter, the SEC must supplement its flawed VaR-based framework with other meaningful leverage constraints. In particular, we recommend that the SEC, at a minimum, adopt a strengthened version of the asset segregation framework in place for funds since the 1970s in addition to VaR-based leverage limitations that account for the most obvious defects of the proposal.”

For more information, please refer to this fact sheet.

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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.