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2012 ICI GMM: Everyone Needs Derivatives, Stevens Says

CFTC Rule Changes 'unwarranted, Costly'


WASHINGTON, D.C. - Investment Company Institute chief executive Paul Schott Stevens said last Wednesday that mutual funds need to make investments in commodities and derivative securities such as futures contracts in order to manage market swings and protect returns of the everyday investors that want the kind of "skills and insights" otherwise "available only to the wealthiest Americans."

"In today's markets, it's difficult to meet that promise efficiently without using options, futures, swaps, and other derivatives,'' he said, in keynote remarks that opened ICI's general membership meeting here. "Funds use these tools to manage risks; to invest more efficiently; and to gain investment exposures to stocks in some foreign markets that are difficult or costly to access directly."

Stevens called changes made in February by the Commodity Futures Trading Commission to a rule affecting commodity pool operators and commodity trading advisors "unwarranted, redundant, and costly amendments.''

On February 9, the CFTC announced the adoption of final rules amending the registration and compliance obligations for CPOs and CTAs.

In March, at ICI's Mutual Funds conference in Phoenix, ICI general counsel Karrie McMillan said the requirements, which could put mutual funds under the oversight of both the CFTC and the Securities and Exchange Commission, "at once duplicative and fundamentally inconsistent.''

The CFTC amended 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 CPOs if they trade more than 5% of their liquidated asset value in speculative commodities trading.

Within a month of McMillan's speech, the ICI had joined with the U.S. Chamber of Commerce in a court challenge to the amendments, alleging that the CFTC rule changes violate both the Commodity Exchange Act and the Administrative Procedure Act on multiple accounts.

Under Rule 4.5, Schott noted that the CFTC has excluded insurance companies, banks, and pension plans from its regulatory regime.

"And since 2003, the CFTC treated registered investment companies and their advisers the same way,'' he said, indicating mutual funds should also be excluded. "After all-what financial product is more comprehensively regulated than mutual funds?"

The new tests are so stringent, though, he said, "that virtually every fund adviser will need to monitor its use of derivatives on a regular basis.''

And some will be subject to CFTC regulation atop their current SEC oversight-a redundant, costly regime that will harm their investors, in his estimate.

If the changes are followed, funds' ability to protect investors against market swings and benefit from market movements will be affected. That could lower returns and lead to redemptions, he indicated.

Meeting both CFTC and SEC rules, even though there is supposed to be 'harmonization' of these, could prove to be a "redundant, costly regime,'' he said.

"The CFTC's actions fly in the face of the agency's legal obligations for rulemaking,'' he said. "After all, the CFTC made no attempt to demonstrate that SEC regulation of funds and advisers does not provide adequate investor protection."

He said the court challenge is "a highly unusual step for us,'' but one that "answers a highly unusual provocation."

Mutual fund investors "benefit greatly from funds that use derivatives to provide investors some exposure to a broad basket of commodities-from energy to precious metals to agricultural products,'' he said. Such investments offer "valuable portfolio diversification," because commodities prices do not move in lockstep with stock or bond returns.

"And as raw materials for the goods that businesses and consumers buy, commodities offer investors an opportunity to protect themselves from inflation,'' he said.

He said this use of derivatives has come under attack "from political leaders who seek to blame rising oil prices on mutual fund investors.

"They charge that investors' expanded use of commodity investing-through relatively new products such as commodity mutual funds-is responsible for rising and volatile prices,'' he said. "They attack our funds as 'speculators.'"

These critics are wrong on the facts-and wrong on the economics, he said.

Academic studies "have demonstrated that the so-called 'financialization' of commodities markets is not driving price developments in individual markets. Nor is it increasing volatility,'' he said.

To support the point, he then cited research released by ICI's research arm. The ICI paper uses statistical techniques to predict how the value of the U.S. dollar and growth in emerging markets affect commodities prices. "Those two economic factors alone explain most of the change in commodities prices,'' he said.

And, he said, there's scarcely any connection between flows to commodity mutual funds and prices in commodity markets.

"That's not surprising,'' he said. "How much impact could $48 billion in commodity mutual fund assets have on markets where trillions of dollars worth of goods and derivatives are exchanged?"

Commodity mutual funds do not influence commodity markets. "And penalizing those funds unjustly will only hurt millions of average American investors,'' he said.

More than 90 million shareholders have put roughly $13 trillion in assets into more than 9,000 mutual funds, at this point, he noted.

The ICI is also challenging - so far out of court - moves expected from the SEC to put a new tighter set of restrictions on money market funds. One proposal in the wind is allowing the net asset value of such funds to float at the end of each day from the historical benchmark of $1 a share, fixed.

He said the ICI was taking aggressive stances with the CFTC and SEC moves with "reluctance,'' in order to protect both individual and institutional investors.

In money market funds, the lion's share of assets are controlled by large institutions.