WASHINGTON - Rep. Edward Markey, D-Mass., and Rep. Jack Fields, R-Tex., asked the Securieties and Exchange Commission yesterday to conduct a comprehensive study on the use of derivatives by mutual funds.
The SEC should consider whether changes in securities laws and rules are needed to govern funds' derivatives activities and advise the subcommittee about whether derivatives are appropriate for money market portfolios, the chairman and top Republican of the House Energy and Commerce subcommittee on telecommunications and finance said in a letter to the commission.
"We believe that such a study is warranted in light of a small but growing number of reports of substantial losses apparently attributable to derivatives holdings at certain mutual funds," the two lawmakers said in the letter to SEC Chairman Arthur Levitt Jr.
Some of those losses appeared to have been rapidly incurred by short-term government bond and money market funds, which investors historically believe are cautions and conservative, Markey and Fields said.
The lawmakers asked the SEC to report back to the subcommittee by July 18.
The SEC study would affect municipal as well as taxable derivatives, said one mutual fund expert, because many municipal derivatives were developed with the aim of synthetically converting long-term bonds into short-term variable-rate products that could be purchased by money market funds.
The SEC's Rule 2a-7 sets limits on the maturity, diversification, and quality of money market fund portfolios.
But federal regulators have testified before the subcommittee that money market and mutual funds' use of derivatives is limited, though growing.
And Markey and Fields appeared most concerned about the speclative use of derivatives by mutual funds.
"It is now abundantly clear that derivatives can create risk as well as hedge against it," the lawmakers said in their letter.
"Obviously, to the extent that mutual funds engage in speculative derivatives activity involving volatile derivatives instruments, they pass this risk onto their shareholders around the country," they said.
The issue as a "high priority" for the subcommottee and "something we are very intensively pursuing right now," said one subcommittee aide.
In their letter, Markey and Fields asked the SEC to examine specific issues of importance to the subcommittee. These include whether:
* The SEC has adequate information about the derivatives activities of mutual funds;
* Mutual funs provide meaningful information to investors about their derivatives activities;
* The competition for assets within the industry is so intense that funds that are normally conservative become engaged in more risky derivatives activities to outperform their rivals;
* Certain derivatives products are so exotic and illiquid that they interfere with a fund's need to establish a daily price for its shares'
* Certain derivative productrs are so illiquid that a mutual fund purchasing them would run the risk of violating an SEC rule that prohibits it from holding more than 15% of its assets in illiquid instruments;
* Funds use derivatives, in some cases, to build enourmous leverage into their portfolios and whether this is permitted under securities laws;
* Bank mutual funds face special undisclosed risks because banks need to meet certain capital requirements and might not be able to make capital infusions to cover losses.
The two lawmakers asked the SEC whether derivatives are appropriate for money market portfolios, given the recent instability among some money market mutual funds.
