Division of Investment Management Staff Statement Regarding Termination Notice for Exemptive Relief and Withdrawal of Staff Letters Related to COVID-19 Response
The SEC’s Division of Investment Management issued an update concerning temporary relief it has issued in the wake of the COVID-19 pandemic. As previously committed, the staff provided two weeks’ advance notice that it would be terminating temporary relief concerning interfund lending and affiliated purchases of debt. First, the staff terminated a conditional exemptive order that had provided temporary flexibility to obtain short-term funding for mutual funds (except money market funds) and insurance company separate accounts registered as UITs. The staff also terminated two no-action letters that allowed certain affiliates to purchase securities from a money market fund or debt securities from a mutual fund under specified conditions. Both sets of relief were terminated effective April 30, 2021. The Division’s staff statement can be found at the link below.
There still has not been any word on discontinuing relief from the in-person board meeting requirements, though it seems unlikely the staff would require in-person meetings any time soon given continued uncertainty surrounding new COVID-19 variants coupled with the fact that the SEC staff itself is not returning to its offices this fall.
Risk Alert: The Division of Examinations’ Review of ESG Investing*
Recognizing the state of regulatory flux around ESG standards, the Division of Exams has issued a risk alert regarding ESG investing. ESG is somewhat of a wild west because there are few standards or precise definitions that govern ESG marketing, and the agency is concerned that asset managers will “green wash” their products to increase distribution to ESG-minded consumers. This alert picks up on that theme, reporting the staff’s observations about misleading disclosures, inconsistencies between disclosures and practices, and proxy practices that fail to adhere to supposed ESG restrictions. This alert should be read in conjunction with the 2021 exam priorities, which also focused on ESG investing (among other topics), as well as a push among some commissioners to impose regulation in the space either via Rule 35d-1 or general disclosure or proxy rules.
Of particular interest for our clients, the alert noted that written policies and procedures often were not reasonably designed, or not implemented, to provide for compliance oversight of ESG investing practices and disclosures. The staff observed that policies and procedures did not address ESG investing analyses, decision-making processes, or compliance review and oversight, and written policies were sometimes weak or vague, and controls were not being followed. Compliance was particularly weak where compliance personnel had limited knowledge of ESG issues. Disclosures also often reflected unsubstantiated claims or failed to disclose all material facts. The staff credited firms that made clear that ESG factors would be considered alongside many other factors, thus allowing a firm to hedge when they seemingly followed somewhat inconsistent (non-ESG) investments. They also noted approvingly where firms utilized documentation at various stages of the investment process and had compliance personnel integrated into the ESG-related processes. For more information, please follow this link to the SEC’s website:
Staff Statement: Registered Funds Investing in Bitcoin Futures
The Division of Investment Management has issued a statement concerning investments by registered funds in the Bitcoin futures market, sanctioning investing in cash-settled Bitcoin futures so long as the fund has suitable policies and procedures in place and it discloses the risks. Conspicuously, the staff does not mention other cryptocurrencies. The staff emphasized that funds must consider valuation, liquidity, custody, arbitrage for ETFs, and manipulation risk with cryptocurrencies; the staff evidently believes the Bitcoin futures market is sufficiently mature to address those risks, but they suggest funds should proceed with caution, and only those funds with “appropriate strategies” and “full disclosure of material risks” should be investing. Consequently, funds investing in such digital assets should expect scrutiny from the Division of Examinations, which will be looking closely at policies and procedures, risk management (including derivatives risk management under 18f-4), and disclosures.
The staff suggest that open-end mutual funds can invest up to 15% of their assets in Bitcoin futures, effectively treating the investment like an illiquid investment (which one might argue conflates volatility and liquidity). The staff telegraphed that it is not yet ready to approve ETFs investing in Bitcoin because they are concerned that ETFs cannot control subscription and redemption flows on exchanges. (More recently, the SEC has again extended the review period for a bitcoin ETF, signaling that its concerns have not abated.) The staff also suggested that closed-end funds may have more leeway because they do not have to meet daily redemptions, but such funds should consult the staff before filing a registration statement. There was no mention of investing directly in grantor trusts (e.g., Grayscale Bitcoin Trust), which are exchange-traded and provide only indirect exposure to the Bitcoin market. The staff previously has expressed support for funds investing as such, again subject to 15% limits, and many funds in fact already invest in Grayscale and similar products. Advisers should be mindful, however, that grantor trusts produce “bad income” for purposes of the Internal Revenue Code 90% gross income test. For more information about the staff statement, please follow this link to the SEC’s website:
SEC Regulatory Flex Agenda
The SEC has published its Agency Rule List for Spring 2021 pursuant to the Regulatory Flexibility Act. While much of the agenda has been coopted from the prior chairman’s agenda, there are several changes reflecting the priorities of the new chairman. Some notable items on the short-term agenda (i.e., items expected to have some regulatory action in the next 12 months) that may impact the fund industry include possible amendments to the rules for the proxy voting advice rule, custody for investment advisers, ESG disclosures, and shareholder reporting. The agency also is considering amendments to the requirements for open-end fund “liquidity and dilution management” – a tantalizing prospect for ratcheting back requirements for most funds for which the risk management rules seem more onerous than useful, or perhaps increasing requirements for those funds that faced particular stresses during pandemic-induced market volatility. The agency also is considering disclosure rules for reporting companies that could find their way into fund requirements. This includes disclosures around board diversity, climate change, human capital management, and cybersecurity governance. The agency is also evaluating possibly shortening the settlement cycle (to T+1 or T+0?). On the long-term agenda (where regulatory action is expected more than 12 months from now), the SEC is considering amending the custody rule for investment companies (a likely companion to updates to the adviser custody rule), proxy governance (a possible roll-back of the Chairman Clayton-era constraints on proxy advice firms?), updates to the names rule (Rule 35d-1, a likely vehicle for some ESG guardrails), and securities lending.
This agenda is no doubt equal to the ambition of the prior SEC chairman but takes a different tact. It remains to be seen, however, whether Chairman Gensler pushes a muscular regulatory approach or instead merely aims to modernize existing regulations and fine-tune rules to be more responsive to current policy debates. For more information, please follow the links to the Office of Information and Regulatory Affairs website.