that use derivatives, or the other transactions that rule 18f-4
addresses, more substantially. We estimate that the total industry cost
for the final rule's recordkeeping requirement in the first year will
equal $53,012,728.\923\
---------------------------------------------------------------------------

    \923\ The burdens associated with this estimate are all
paperwork-related burdens, and thus they are also estimated in the
Paperwork Reduction Act Analysis section of this release. See infra
section IV.B.7.The total industry cost estimate is then based on the
following calculations: First, 9 hours x $63 (general clerk) = $567,
9 hours x $96 (senior computer operator) = $864, and 9 hours x $368
(compliance attorney) = $3,312, for a total of $567 + $864 + $3,312
+ ($1,800 for initial external cost burden) = $6,543, which is the
one-time cost per non-limited derivatives user fund for establishing
recordkeeping policies and procedures for derivatives risk
management program and VaR requirements; Second, 16 hours x $63
(general clerk) = $1,008, 16 hours x $96 (senior computer operator)
= $1,536, and 16 hours x $368 (compliance attorney) = $5,888, for a
total of $1,008 + $1,536 + $5,888 = $8,432, which is the annual
ongoing recordkeeping cost per non-limited derivatives user fund for
derivatives risk management program and VaR requirements; Third, 1.5
hours x $63 (general clerk) = $95, 1.5 hours x $96 (senior computer
operator) = $144, and 1.5 hours x $368 (compliance attorney) = $552,
for a total of $95 + $144 + $552 + ($1,800 for initial external cost
burden) = $2,591, which is the one-time cost per limited derivatives
user fund for establishing recordkeeping policies and procedures;
Fourth, 2 hours x $63 (general clerk) = $126, 2 hours x $96 (senior
computer operator) = $192, and 2 hours x $368 (compliance attorney)
= $736, for a total of $126 + $192 + $736 = $1,054, which is the
annual ongoing recordkeeping cost per limited derivatives user fund
or a fund engaging in unfunded commitment agreements; Fifth, 1.5
hours x $63 (general clerk) = $95, 1.5 hours x $96 (senior computer
operator) = $144, and 1.5 hours x $368 (compliance attorney) = $552,
for a total of $95 + $144 + $552 = $791, which is the one-time cost
per fund engaging in unfunded commitment agreements or reverse
repurchase agreements for establishing recordkeeping policies and
procedures; Lastly, 1 hour x $63 (general clerk) = $63, 1 hour x $96
(senior computer operator) = $96, and 1 hour x $368 (compliance
attorney) = $368, for a total of $63 + $96 + $368 = $527, which is
the annual ongoing recordkeeping cost per fund engaging in reverse
repurchase agreements; Total industry costs associated with
recordkeeping requirements are estimated as: (2,766 funds which
cannot rely on the limited derivatives user exception) x ($6,543 +
$8,432) = $41,420,850; (2,437 funds which can rely on the limited
derivatives user exception) x ($2,591 + $1,054) = $8,882,865; (1,339
funds engaging in unfunded commitment agreements) x ($791 + $1,054)
= $2,470,455; (181 funds engaging in reverse repurchase agreements)
x ($791 + $527) = $238,558 for a total of $53,012,728.
---------------------------------------------------------------------------

9. Amendments To Fund Reporting Requirements
a. Form N-PORT and Form N-CEN
    We are amending Form N-PORT to include a new reporting item on
limited derivatives users' derivatives exposure, which will be non-
public because we are collecting this information for regulatory
purposes.\924\ This new item requires a limited derivatives user to
report: (1) The fund's derivatives exposure; and (2) the fund's
derivatives exposure attributable to currency or interest rate
derivatives entered into and maintained by the fund for hedging
purposes. Furthermore, if a fund relying on that exception has
derivatives exposure exceeding 10% of the fund's net assets, and this
exceedance persists beyond the five-business-day period that the final
rule provides for remediation, the fund will have to report the number
of business days beyond the five-business-day remediation period that
its derivatives exposure exceeded 10% of net assets.\925\ In addition,
we are adopting a new Form N-PORT reporting item related to the VaR
tests we are adopting, in which funds that are subject to the final
rule's VaR-based limit on fund leverage risk will have to report
certain information related to their VaR.\926\
---------------------------------------------------------------------------

    \924\ See supra section II.G.1.a.
    \925\ Id.
    \926\ Specifically, this information will include the fund's
median daily VaR for the reporting period. Funds subject to the
relative VaR test during the reporting period also will have to
report: (1) The name of the fund's designated index or a statement
that the fund used its securities portfolio as its designated
reference portfolio; (2) the index identifier; and (3) the fund's
median daily VaR Ratio for the reporting period. Finally, all funds
that are subject to the limit on fund leverage risk also will have
to report the number of exceptions that the fund identified as a
result of the backtesting of its VaR calculation model. Information
about a fund's designated index will be made publicly available, but
not a fund's median daily VaR, median daily VaR ratio, and
backtesting information. See supra section II.G.1.b.
---------------------------------------------------------------------------

    We also are amending Form N-CEN to require a fund relying on the
final rule to identify that it is relying on the rule in the first
instance, as well as: (1) Whether it is a limited derivatives user
excepted from the rule's program requirement and VaR tests; (2) whether
it is a leveraged/inverse fund as defined in the rule; (3) whether it
has entered into reverse repurchase agreements or similar financing
transactions, either under the provision of rule 18f-4 that requires a
fund to comply with the asset coverage requirements of section 18 or
under the provision that requires a fund to treat such transactions as
derivative transactions under the final rule; (4) whether it has
entered into unfunded commitment agreements under rule 18f-4; and (5)
whether it is relying on the provision of rule 18f-4 that addresses
investment in when-issued and forward-settling securities. All new
information reported in Form N-CEN pursuant to this rulemaking will be
made publicly available. These additional reporting requirements will
not apply to BDCs,

which do not file reports on Form N-CEN or Form N-PORT.\927\
---------------------------------------------------------------------------

    \927\ See supra footnote 625.
---------------------------------------------------------------------------

    To the extent that the information that we will require funds to
report on Forms N-PORT and N-CEN is not currently available, the
requirements that funds make such information available periodically on
these forms will improve the ability of the Commission to oversee
reporting funds. It also will allow the Commission and its staff to
oversee and monitor reporting funds' compliance with the final rule and
help identify trends in reporting funds' use of derivatives. The
expanded reporting also will increase the ability of the Commission
staff to identify trends in investment strategies and fund products in
reporting funds as well as industry outliers.\928\
---------------------------------------------------------------------------

    \928\ The structuring of the information in Form N-PORT will
improve the ability of Commission staff to compile and aggregate
information across all reporting funds, and to analyze individual
funds or a group of funds, and will increase the overall efficiency
of staff in analyzing the information.
---------------------------------------------------------------------------

    Investors, third-party information providers, and other potential
users may also experience benefits from the amendments to Forms N-PORT
(that relate to information that will be publicly available) and N-CEN,
as they will require the disclosure of additional information that is
not currently available elsewhere and that may allow the users of this
data to better differentiate funds.
    As discussed below in section IV.D, our estimated average one-time
and ongoing annual costs associated with the amendments to Forms N-PORT
take into account the fact that only certain funds--those that rely on
the limited derivatives user exception, and those that are subject to
the VaR-based limit on fund leverage risk in final rule 18f-4--will
incur these costs. We estimate that the total industry cost for these
new Form N-PORT reporting requirements in the first year will equal
$18,033,889.\929\ We also estimate that the total industry cost for all
registered funds associated with these new Form N-CEN reporting
requirements in the first year will equal $775,570.\930\
---------------------------------------------------------------------------

    \929\ The burdens associated with this estimate are all
paperwork-related burdens, and thus they are also estimated in the
Paperwork Reduction Act Analysis section of this release. See infra
section IV.D. The total industry estimate is based on the following
calculations: First, (2 hours x $368 (compliance attorney) + 2 hours
x $334 (senior programmer) = $1,404), which is the average, one-time
cost per limited derivatives user to comply with the new N-PORT
requirements of derivatives exposure information in the first
reporting quarter of the fiscal year; Second, (3 hours x $368
(compliance attorney) + 3 hours x $334 (senior programmer) = $2,106
per year), which is the ongoing cost per limited derivatives user to
comply with the new N-PORT requirements of derivatives exposure
information in the final three reporting quarters of the fiscal
year; Third, (2 hours x $368 (compliance attorney) + 2 hours x $334
(senior programmer) = $1,404), which is the average, one-time cost
per fund to comply with the new N-PORT requirements of VaR-related
information in the first reporting quarter of the fiscal year;
Fourth, (3 hours x $368 (compliance attorney) + 3 hours x $334
(senior programmer) = $2,106 per year), which is the ongoing cost
per fund to comply with the new N-PORT requirements of VaR-related
information in the final three reporting quarters of the fiscal
year; Lastly, (0.01 hours x $368 (compliance attorney) + 0.01 hours
x $334 (senior programmer) = $7), which is the ongoing cost per
limited derivatives that reports exceedances of 10% derivatives
exposure threshold in the fiscal year. The total industry cost for
these reporting requirements in the first year is: ((2,437
registered funds that are limited derivatives users and required to
provide information about their derivatives exposure and exceedances
of the 10% threshold on N-PORT) x ($1,404 + $2,106 + $7) =
$8,570,929) + (2,696 registered funds subject to the VaR-based limit
on fund leverage risk in rule 18f-4 x ($1,404 + $2,106) =
$9,462,960) = $18,033,889.
    \930\ The burdens associated with this estimate are all
paperwork-related burdens, and thus they are also estimated in the
Paperwork Reduction Act Analysis section of this release. See infra
section IV.F. The estimate is based on the following calculations:
First, we calculate the ongoing annual cost for a registered fund
required to prepare amendments to Form N-CEN, which is 0.2 hours x
$368 (compliance attorney) + 0.2 hours x $334 (senior programmer) =
$73.6 + $66.8 = $140.4 per year; Lastly, the total industry cost for
all registered funds associated with this reporting requirement in
the first year is (5,524 registered funds required to prepare a
report on Form N-CEN as amended) x $140.4 = $775,570.
---------------------------------------------------------------------------

b. Amendments to Current Reporting Requirements
    We are also adopting current reporting requirements for funds that
will rely on rule 18f-4 and will be subject to the VaR-based limit on
fund leverage risk. Specifically, if a fund is subject to the relative
VaR test, and the VaR of its portfolio exceeds 200% or 250% (depending
on whether the fund is a closed-end fund for which the higher threshold
is applicable) of the VaR of its designated reference portfolio for
five business days, the fund will be required to file a non-public
report on Form N-RN.\931\ The report must include the following
information: (1) The dates on which the fund's portfolio VaR exceeded
200% or 250% of the VaR of the designated reference portfolio; (2) the
fund portfolio's VaR for each of these days; (3) the VaR of the
designated reference portfolio for each of these days; (4) the
designated index or statement that the fund used its securities
portfolio as its designated reference portfolio; and (5) the index
identifier, if applicable. The fund also will have to file a report on
Form N-RN when it is back in compliance with its applicable VaR
test.\932\ Similarly, if a fund is subject to the absolute VaR test,
and its absolute VaR exceeds 20% or 25% (as applicable) of the fund's
net asset value for five business days, the fund will be required to
file a comparable report on Form N-RN and a report when the fund is
back in compliance.\933\
---------------------------------------------------------------------------

    \931\ As proposed, we are requiring all funds that are subject
to rule 18f-4's limit on fund leverage risk to file current reports
on Form N-RN regarding VaR test breaches. See also supra footnote
688.
    \932\ See supra footnote 682.
    \933\ See supra footnote 685.
---------------------------------------------------------------------------

    We anticipate that the enhanced current reporting requirements
could produce significant benefits. For example, when a fund is out of
compliance with the VaR-based limit on fund leverage risk, this may
indicate that a fund is experiencing heightened risks as a result of a
fund's use of derivatives transactions. Such breaches also could
indicate market events that are drivers of potential derivatives risks
across the fund industry and therefore complement other sources of
information related to such market events for the Commission. As a
result, we believe that the final rule's current reporting requirement
will increase the effectiveness of the Commission's oversight of the
fund industry by providing the Commission with current information
regarding potential increased risks and stress events, which in turn
will benefit investors.\934\
---------------------------------------------------------------------------

    \934\ See supra section II.G.2 for a discussion of the comments
we received on the proposed current reporting requirements.
---------------------------------------------------------------------------

    As discussed below in section IV.E, our estimated average cost
burdens associated with the amendments to Form N-RN take into account
that only certain funds--those that are out of compliance with the VaR-
based limit on fund leverage risk that Form N-RN describes--will be
required to file reports on Form N-RN, as amended. We estimate that the
total industry cost for this reporting requirement in the first year
will be $77,652.\935\
---------------------------------------------------------------------------

    \935\ The burdens associated with this estimate are all
paperwork-related burdens, and thus they are also estimated in the
Paperwork Reduction Act Analysis section of this release. See infra
sections IV.E and V.D.2.b. This estimate is based on the assumption
that 27 funds will have to file reports on Form N-RN per year and
corresponds to a cost of $2,876 for each filing fund ($1,438 per
filing, and a fund will have to file two reports per breach
incident: One to report the breach, and one when the fund is back in
compliance with the VaR test ($1,438 x 2 = $2,876)).
---------------------------------------------------------------------------

    We do not believe there will be any potential indirect costs
associated with filing Form N-RN, such as spillover effects or the
potential for investor flight due to a VaR test breach (to the extent
that investors would leave a fund if they believed a fund's VaR test
breaches indicate that a fund has a risk profile that is inconsistent
with their investment goals and risk tolerance),

because Form N-RN filings will not be publicly disclosed.\936\ Because
the Form N-RN filing requirements will be triggered by events that are
part of a fund's requirement to determine compliance with the
applicable VaR test at least daily, any monitoring costs associated
with Form N-RN are included in our estimates of the compliance costs
for rule 18f-4 above.
---------------------------------------------------------------------------

    \936\ See also supra footnote 697 and accompanying text
(discussing that a fund may not engage in ``fire sales'' to avoid
filing a report on Form N-RN.)
---------------------------------------------------------------------------

10. When-Issued and Forward-Settling Transactions
    The final rule includes a provision that will permit funds, as well
as money market funds, to invest in securities on a when-issued or
forward-settling basis, or with a non-standard settlement cycle,
subject to conditions.\937\ This provision reflects our view that the
potential for leveraging is limited in these transactions when they
meet the conditions in this provision. We do not believe that this
provision will result in a significant change in the extent to which
funds and money market funds engage in these transactions. For example,
money market funds will continue to be able to invest in when-issued
U.S. Treasury securities under this provision notwithstanding that
these investments trade on a forward basis involving a temporary delay
between the transaction's trade date and settlement date. We therefore
do not expect these amendments to result in significant costs to funds,
as well as money market funds.\938\
---------------------------------------------------------------------------

    \937\ See supra sections I.C. and II.A.
    \938\ Money market funds may be required to make certain
disclosure changes to their prospectuses. The burdens associated
with this estimate are all paperwork-related burdens, and thus they
are also estimated in the Paperwork Reduction Act Analysis section
of this release. See infra sections IV.B.5 and IV.B.7. We estimate
that the total industry cost for disclosure changes for money market
funds in the first year would equal $285,600. The estimate is based
on the following calculations: First, we calculate the one-time cost
for disclosure changes for money market funds, which is 3 hours x
$312 (compliance manager) + 3 hours x $368 (compliance attorney) =
$936 + $1,104 = $2,040 per year; The total industry cost for
disclosure changes for money market funds, in the first year, is
(420 registered money market funds) x $2,040 = $856,800.
---------------------------------------------------------------------------

D. Effects on Efficiency, Competition, and Capital Formation

    This section evaluates the impact of the final rules on efficiency,
competition, and capital formation. We are unable to quantify these
effects, however, because we lack the information necessary to provide
a reasonable estimate. For example, we are unable to predict how the
final rules will change investors' propensity to invest in funds and
ultimately affect capital formation. Therefore, much of the discussion
below is qualitative in nature, although where possible we attempt to
describe the direction of the economic effects.
1. Efficiency
    Rule 18f-4 in conjunction with the rescission of Release 10666 may
make derivatives use more efficient for certain funds, including for
those funds that will qualify as limited derivatives users.
Specifically, funds' current asset segregation practices may provide a
disincentive to use derivatives for which notional amount segregation
is the practice, even if such derivatives would otherwise provide a
lower-cost method of achieving desired exposures than purchasing the
underlying reference asset directly.\939\ For example, a fund seeking
to sell credit default swaps to take a position in an issuer's credit
risk may currently choose not to do so because of the large notional
amounts that the fund would segregate for that specific derivatives
position. The final rule therefore could increase efficiency by
mitigating current incentives for funds to avoid use of certain
derivatives (even if foregoing the use of those derivatives would
entail cost and operational efficiencies).
---------------------------------------------------------------------------

    \939\ See supra section III.B.3 (for a description of funds'
current asset segregation practices).
---------------------------------------------------------------------------

    In addition, the final rules may change the degree to which some
funds choose to use derivatives generally or the degree to which funds
use certain derivatives over others.\940\ Changes in the degree to
which certain derivatives are used by funds could affect the liquidity
and price efficiency of these derivatives. Although unaddressed in the
academic literature, we expect an increase in the use of derivatives to
correspond to an increase in derivatives market liquidity as more
derivatives contracts may be easily bought or sold in markets in any
given period, as well as an increase in price efficiency since
information regarding underlying securities (and other factors that
affect derivatives prices) may be better reflected in the prices of
derivative contracts.
---------------------------------------------------------------------------

    \940\ Specifically, (1) as discussed in the previous paragraph,
funds may transact in more notional-value based derivatives as a
result of removing the incentive distortion of notional- vs. market-
value asset segregation under funds' current asset segregation
practices; (2) new potential funds may reduce their use of
derivatives transactions to satisfy the VaR-based limit on fund
leverage risk (see supra section III.C.2); (3) existing funds may
change their use of derivatives transactions to respond to risks
identified after adopting and implementing their derivatives risk
management programs (see supra section III.C.1); (4) both existing
and new potential funds may increase their use of derivatives
transactions as a result of the exemptive rule's bright-line limits
on leverage risk (see supra section III.C.2); and (5) the use of
derivatives transactions of leveraged/inverse funds with exposure
exceeding 200% may decrease, to the extent that the final rule has
the effect of limiting the growth (or leading to a decline) of
assets managed by these funds over time as a result of limiting
leveraged/funds with exposures above this limit to those currently
in operation (see supra section III.C.5). Overall, the effect of the
final rules on funds use of derivatives transactions is ambiguous
and depends on the type of derivatives transaction.
---------------------------------------------------------------------------

    Changes in the degree to which certain derivatives are used could
also affect the pricing efficiency and liquidity of securities
underlying these derivatives and those of related securities. For
example, one paper provides evidence that the introduction of credit
default swap contracts decreases the liquidity and price efficiency of
the equity security of the issuer referenced in the swap.\941\
Conversely, the paper also observes that the introduction of exchange-
traded stock option contracts improves the liquidity and price
efficiency of the underlying stocks.
---------------------------------------------------------------------------

    \941\ This paper analyzed NYSE-listed firms and observed that,
all else equal, equity markets become less liquid and equity prices
become less efficient when single-name credit default swap contracts
are introduced, while the opposite results hold when equity options
are listed on exchanges. Ekkehart Boehmer, Sudheer Chava, & Heather
E. Tookes, Related Securities and Equity Market Quality: The Case of
CDS, 50 J. Fin. & Quantitative Analysis 509 (2015), available at
https://www.cambridge.org/core/journals/journal-of-financial-and-quantitative-analysis/article/related-securities-and-equity-market-quality-the-case-of-cds/08DE66A250F9950FA486AE818D5E0341. The latter
result, that traded equity options are associated with more liquid
and efficient equity prices, is consistent with several other
academic papers. See, e.g., Charles Cao, Zhiwu Chen, & John M.
Griffin, Informational Content of Option Volume Prior to Takeovers,
78 J. Bus. 1073 (2005), as well as Jun Pan & Allen M. Poteshman, The
Information in Option Volume for Future Stock Prices, 19 Rev. Fin.
Stud. 871 (2006). The effects described in the literature are based
on studies of the introduction of derivative securities and may
therefore apply differently to changes in the trading volume of
derivatives securities that may occur as a result of the final rule.
---------------------------------------------------------------------------

    The final rule's VaR-based limit on fund leverage risk will also
establish a bright-line limit on the amount of leverage risk that a
fund can take on using derivatives.\942\ As we stated in the Proposing
Release, to the extent that funds are more comfortable with managing
their derivatives exposures to a clear outside limit, this could
improve the efficiency of funds' portfolio risk management
practices.\943\ One commenter disagreed with this assessment, stating
that a bright-line limit would not improve the efficiency of funds'
portfolio risk management

practices.\944\ However, the commenter did not provide any data or
evidence that contradicts the possibility that funds may find it more
efficient to manage to clearly defined limits than the current
approach. We therefore continue to believe that some funds may be able
to manage portfolio risk more efficiently in the presence of a clear
outside limit, as compared to the baseline, which provides less clear
and uniform limitations on funds' derivatives use owing to its
development on an instrument-by-instrument basis through a combination
of Commission guidance in Release 10666, staff no-action letters, and
other staff guidance.
---------------------------------------------------------------------------

    \942\ See supra section III.C.2.
    \943\ See Proposing Release, supra footnote 1, at section
III.D.1.
    \944\ See ProShares Comment Letter.
---------------------------------------------------------------------------

    In addition, the recordkeeping elements of rule 18f-4 will
facilitate efficient evaluation of compliance with the rule while also
providing the Commission with information that may be useful in
assessing market risks associated with derivatives products. Moreover,
the amendments to fund's current reporting requirements could
facilitate the Commission's oversight of funds subject to rule 18f-4
with fewer resources.\945\
---------------------------------------------------------------------------

    \945\ See supra section II.G.2.
---------------------------------------------------------------------------

    The amendments to Forms N-PORT and N-CEN will allow investors, to
the extent that they use the information, to better differentiate
between funds based on their derivatives usage.\946\ As a result,
investors will be able to more efficiently evaluate the effects of a
fund's use of derivatives as part of its investment strategies,
allowing them to make better-informed investment decisions.
---------------------------------------------------------------------------

    \946\ See supra section III.C.9.a.
---------------------------------------------------------------------------

    In addition, the final rules may affect market quality for some of
the investments held by leveraged/inverse ETFs, to the extent that the
rule changes the amount and composition of investments by leveraged/
inverse ETFs as a whole. Specifically, the academic literature to date
provides some evidence, albeit inconclusive, that leveraged/inverse
ETFs' rebalancing activity may have an impact on the price and
volatility of the constituent assets that make up the ETFs. For
example, one paper empirically tests whether the rebalancing activity
of leveraged/inverse ETFs impacts the price and price volatility of
underlying stocks.\947\ The authors find a positive association,
suggesting that rebalancing demand may affect the price and price
volatility of component stocks, and may reduce the degree to which
prices reflect fundamental value of the component stocks. As leveraged/
inverse ETFs commonly use derivatives to rebalance their portfolios,
similar effects could also extend to underlying derivatives, although
we are not aware of any academic literature that has examined the
effects of leveraged/inverse ETFs' rebalancing activity on derivatives
markets. Conversely, another paper argues that the existing literature
that studies the effect of leveraged/inverse ETFs' rebalancing activity
on the constituent asset prices does not control for the effect of the
creation and redemption transactions (i.e., fund flows) by authorized
participants.\948\ The paper presents evidence that positively
leveraged/inverse ETFs tend to have capital flows in the opposite
direction of the underlying index, and inverse leveraged/inverse ETFs
tend to have capital flows in the same direction as the underlying
index, suggesting that investor behavior may attenuate the effect of
leveraged/inverse ETFs' rebalancing activity on the prices of
underlying securities and derivatives.\949\ We are unable to determine,
however, which holdings of leveraged/inverse ETFs are likely to be
positively affected and which may be negatively affected, as we lack
the information necessary to predict the effect that the amendments to
rule 6c-11 and the prohibition on launching new funds with exposures
above 200% that cannot satisfy rule 18f-4's relative VaR test will have
on the size and composition of leveraged/inverse ETFs' portfolios.
---------------------------------------------------------------------------

    \947\ See Qing Bai, Shaun A. Bond & Brian Hatch, The Impact of
Leveraged and Inverse ETFs on Underlying Real Estate Returns, 43
Real Estate Econ. 37 (2015).
    \948\ See Ivan T. Ivanov & Stephen Lenkey, Are Concerns About
Leveraged ETFs Overblown?, (FEDS, Working Paper No. 2014-106, 2014).
    \949\ The literature we are aware of focuses on leveraged/
inverse ETFs and does not study similar effects of leveraged/inverse
mutual funds, although both types of funds generally engage in
similar rebalancing activity. As a result, similar effects may be
attributable to leveraged/inverse mutual funds.
---------------------------------------------------------------------------

2. Competition
    Certain aspects of the final rules may have an impact on
competition.\950\ Certain of these potential competitive effects result
from the final rule imposing differential costs on different funds.
Specifically: (1) Large fund complexes may find it less costly to
comply per fund with the new requirements of rule 18f-4 as a whole;
\951\ (2) funds that already have robust derivatives risk management
practices in place and funds whose advisers already employ someone with
the relevant expertise to serve as the fund's derivatives risk manager
may incur lower costs associated with the rule's derivatives risk
management program requirements; \952\ (3) funds that qualify as
limited derivatives users will generally incur lower compliance costs
associated with the rule than funds that will not qualify for this
exception; \953\ (4) unlike leveraged/inverse funds with exposures not
exceeding 200%, leveraged/inverse funds with exposures in excess of
this limit will not be subject to the rule's VaR-based limit on fund
leverage risk and will therefore not incur the increased compliance
costs associated with this requirement; \954\ (5) funds that will
comply with the relative VaR test would generally incur higher
compliance costs than those that will comply with the absolute VaR
test; \955\ and (6) BDCs are not subject to the additional reporting
requirements on Forms N-CEN or N-PORT and will therefore not incur the
increased compliance costs that will be imposed on filers of these
forms.\956\ To the extent that investors believe that the funds that
will incur lower compliance burdens and the funds that will incur
higher compliance burdens under the rule are substitutes, the rule may
result in a competitive advantage for funds with the lower compliance
burden to the extent that a lower burden makes such funds less costly
to operate.
---------------------------------------------------------------------------

    \950\ See supra sections III.B.1 and III.B.5 for an overview of
the baseline of the fund industry.
    \951\ See supra sections III.C.1 and III.C.2.
    \952\ See supra section III.C.1.
    \953\ See supra section III.C.3.
    \954\ See supra section II.F.5.
    \955\ See supra section III.C.2.
    \956\ See supra section III.C.9.a.
---------------------------------------------------------------------------

    The final rule may also put funds that are subject to the outer
limit on fund leverage risk at a competitive disadvantage compared to
alternative products that can provide leveraged market exposure but
will not be subject to the VaR-based limit on fund leverage risk of
rule 18f-4, such as existing leveraged/inverse funds with exposures
exceeding 200% that satisfy the conditions to the exception from the
VaR-based limit on fund leverage risk for such funds, alternative
investment vehicles (including the listed commodity pools that would
have been subject to the proposed sales practices rules), exchange-
traded notes, and structured products.\957\
---------------------------------------------------------------------------

    \957\ See also supra section III.C.2.
---------------------------------------------------------------------------

    The Commission has not provided exemptive relief to new prospective
sponsors of leveraged/inverse ETFs since 2009.\958\ The amendments to
rule 6c-11 will allow other leveraged/inverse ETFs with exposures at or
below 200% to enter the leveraged/inverse ETF market, subject to the
conditions in rules 6c-11 and 18f-4, and therefore

help promote a more level playing field. This will likely lead to more
competition among leveraged/inverse ETFs (primarily among those with
exposures at or below 200%) and between leveraged/inverse ETFs and
other products that investors may perceive as substitutes, such as
leveraged/inverse mutual funds. This increase in competition could be
significant, as the leveraged/inverse ETF market is very concentrated;
currently, only two fund sponsors operate leveraged/inverse ETFs. Fees
for leveraged/inverse ETFs and substitute products, such as leveraged/
inverse mutual funds, could fall as a result of any such increase in
competition.
---------------------------------------------------------------------------

    \958\ See supra text following footnote 821.
---------------------------------------------------------------------------

    Conversely, the final rule's prohibition on new leveraged/inverse
funds with market exposure above 200% of the return, or inverse return,
of the relevant index may lead to reduced competition among those
funds, to the extent that the provision reduces the number of such
funds over time.\959\ As a result, fees for leveraged/inverse ETFs with
exposures above this limit may rise.\960\
---------------------------------------------------------------------------

    \959\ In the period following the onset of the COVID-19 health
crisis, certain leveraged/inverse ETFs changed their investment
objectives and strategies. See supra footnote 24. As a result, the
number of leveraged/inverse ETFs with exposures exceeding 200% was
reduced, which is reflected in our baseline statistics in section
III.B.5.
    \960\ Leveraged/inverse funds with exposures above 200% are
currently only offered in the form of ETFs and by two fund sponsors.
We do not expect that the final rule will reduce the number of
sponsors that choose to offer leveraged/inverse ETFs with exposures
above this limit; nor do we believe that the final rule represents a
change from the baseline in terms of the inability of new sponsors
to enter that market, as the Commission has not provided exemptive
relief to new prospective sponsors of leveraged/inverse ETFs since
2009. See supra text following footnote 821.
---------------------------------------------------------------------------

3. Capital Formation
    Certain aspects of the final rules may have an impact on capital
formation.\961\ Certain of these effects may arise from a change in
some investors' propensity to invest in funds, depending on their
preferences for taking risk. For example, some investors may be more
inclined to invest in funds as a result of increased investor
protection arising from any decrease in leverage-related risks; or they
may reduce their investments in certain funds that may increase their
use of derivatives in light of the bright-line VaR-based limit on fund
leverage risk.\962\ Additionally, the rule may lead investors to
increase investments in leveraged/inverse funds with exposures up to
200% as a result of any increase in competition for these funds; and
the rule may lead investors to reduce investments in leveraged/inverse
funds that exceed this exposure as a result of any decrease in
competition or reduced investor choice for those funds.\963\ While we
are unable to determine whether the final rules will lead to an overall
increase or decrease in fund assets, to the extent that overall assets
of funds change, this may have an effect on capital formation.
---------------------------------------------------------------------------

    \961\ See supra sections III.B.1 and III.B.5 for an overview of
the baseline of the fund industry.
    \962\ See supra section III.C.2.
    \963\ See supra sections III.C.5 and III.D.2. Any net change of
assets held by leveraged/inverse funds is likely to have a small
effect on capital formation as only positively leveraged funds
typically invest some portion of their assets into securities
whereas inversely leveraged funds typically achieve their exposures
using only derivatives instruments.
---------------------------------------------------------------------------

    Rule 18f-4 may also decrease the use of reverse repurchase
agreements, similar financing transactions, or borrowings by some
funds, or reduce some funds' ability to invest the borrowings obtained
through reverse repurchase agreements, although the modifications from
the proposal to provide funds additional flexibility to treat these
investments as derivatives transaction may make any decrease less
likely.\964\ To the extent that this restricts a fund's ability to
obtain financing to invest in debt or equity securities, capital
formation may be reduced.
---------------------------------------------------------------------------

    \964\ See supra section III.C.4.
---------------------------------------------------------------------------

E. Reasonable Alternatives

1. Alternative Implementations of the VaR Tests
a. Different Confidence Level or Time Horizon
    Rule 18f-4 will require that a fund's VaR model use a 99%
confidence level and a time horizon of 20 trading days.\965\ We could
alternatively require a different confidence level and/or a different
time horizon for the VaR test. As discussed above in section II.D.4,
market participants calculating VaR most commonly use 95% or 99%
confidence levels and often use time horizons of 10 or 20 days. The VaR
parameters in the final rule therefore represent a confidence level and
time horizon at the high end of what is commonly used.
---------------------------------------------------------------------------

    \965\ See supra section II.D.4.
---------------------------------------------------------------------------

    Compared to requiring a lower confidence level and a shorter time
horizon, the rule's parameters result in a VaR test that is designed to
measure, and therefore limit the severity of, less frequent but larger
losses. However, estimates of VaR at the larger confidence level and
longer time horizon required by the final rule are based on fewer
observations, which reduces the accuracy of the VaR estimate compared
to using a lower confidence level and a shorter time horizon. As
discussed above, we believe certain time- and confidence level scaling
techniques discussed by commenters are appropriate for purposes of the
final rule, which can help reduce the estimation error associated with
VaR calculations and produce more-stable results.\966\
---------------------------------------------------------------------------

    \966\ See supra section II.D.5 (for a more detailed discussion
of the effects of time- and confidence level scaling and the
comments we received on the use of these techniques).
---------------------------------------------------------------------------

b. Absolute VaR Test Only
    To establish an outer limit for a fund's leverage risk, the final
rule will generally require a fund engaging in derivatives transactions
to comply with a relative VaR test; the fund could instead comply with
an absolute VaR test if the fund's derivatives risk manager reasonably
determines that a designated reference portfolio would not provide an
appropriate reference portfolio for purposes of the relative VaR test.
As an alternative, we considered requiring all funds that will be
subject to the VaR-based limit on fund leverage risk to comply with an
absolute VaR test.
    Use of an absolute VaR test would be less costly for some funds
that will be required to comply with the relative VaR test under the
final rule, including because the relative VaR test may require some
funds to pay licensing costs associated with the use of a designated
index.\967\ In addition, use of an absolute VaR test would reduce the
compliance challenge for fund risk managers, who would not have to
consider if a designated reference portfolio would provide an
appropriate reference portfolio for purposes of the relative VaR test.
---------------------------------------------------------------------------

    \967\ See supra section III.C.2. A fund that uses its securities
portfolio as its designated reference portfolio would not incur
these costs.
---------------------------------------------------------------------------

    On the other hand, the absolute VaR test is a static measure of
fund risk in the sense that the implied limit on a fund's VaR will not
change with the VaR of its designated reference portfolio. The absolute
VaR test is therefore less suited for measuring leverage risk and
limiting the degree to which a fund can use derivatives to leverage its
portfolio, as measuring leverage inherently requires comparing a fund's
risk exposure to that of an unleveraged point of reference.\968\ An
additional implication of this aspect of an absolute VaR test is that a
fund may fall out of compliance with an absolute VaR test just because
the market it invests in becomes more volatile, even

though the degree of leverage in the fund's portfolio may not have
changed.
---------------------------------------------------------------------------

    \968\ Id.
---------------------------------------------------------------------------

c. Choice of Absolute or Relative VaR Tests
    As another alternative, we considered allowing derivatives risk
managers to choose between an absolute and a relative VaR limit,
depending on their preferences and without regard to whether a
designated reference portfolio would provide an appropriate reference
portfolio for purposes of the relative VaR test.\969\ Such an
alternative would offer funds more flexibility than the final rule and
could reduce compliance costs for funds, to the extent that derivatives
risk managers would choose the VaR test that is cheaper to implement
for their particular fund. However, this alternative may result in less
uniformity in the outer limit on funds' leverage risk across the
industry, as individual derivatives risk managers would have the
ability to choose between VaR-based tests that could provide for
different limits on fund leverage risk. Funds that invest in assets
with a low VaR, for example, could obtain significantly more leverage
under an absolute VaR test because the VaR of the fund's designated
reference portfolio would be low. In addition, the relative VaR test
resembles the way that section 18 limits a fund's leverage risk.\970\
---------------------------------------------------------------------------

    \969\ Several commenters suggested this alternative. See supra
section II.D.2.a.
    \970\ See id.
---------------------------------------------------------------------------

    We therefore continue to believe that allowing any fund to rely on
the absolute VaR test may be inconsistent with investors' expectations
where a designated reference portfolio would provide an appropriate
reference portfolio for purposes of the relative VaR test.\971\ As a
result, investors in these funds would be less protected from leverage-
related risks compared to the final rule.
---------------------------------------------------------------------------

    \971\ See id.
---------------------------------------------------------------------------

d. Third-Party Validation of a Fund's VaR Model
    Rule 18f-4 does not require third-party validation of a fund's
chosen VaR model. As an alternative, we considered requiring that a
fund obtain third-party validation of its VaR model, either at
inception or in connection with any material changes to the model, to
independently confirm that the model is structurally sound and
adequately captures all material risks.\972\ While such a requirement
could help ensure funds' compliance with the rule's VaR-based limit on
fund leverage risk, this incremental benefit may not justify the
potentially significant additional costs to funds associated with
third-party validation of the fund's VaR model.\973\
---------------------------------------------------------------------------

    \972\ We did not receive any comments on the discussion of this
alternative in the Proposing Release. See Proposing Release, supra
footnote 1, at section III.E.1.e.
    \973\ We note that the UCITS regime requires third-party
validation of funds' VaR models; as a result, these additional costs
could be mitigated for fund that are part of a complex that also
includes UCITS funds. See Proposing Release, supra footnote 1, at n.
243.
---------------------------------------------------------------------------

e. Expected Shortfall or Stressed VaR
    The final rule establishes an outer limit for a fund's leverage
risk using VaR. Alternatively, we could require funds to comply with a
limit based on stressed VaR or expected shortfall. Compared to the
final rule's VaR test, both methodologies focus on more extreme losses,
but also are associated with quantitative challenges inherent in
estimating tail risk.\974\ Stressed VaR, for example, can pose
quantitative challenges by requiring funds to identify a stress period
with a full set of risk factors for which historical data is available.
Expected shortfall, for example, generally is more sensitive to extreme
outlier losses than VaR calculations because expected shortfall is
based on an average of a small number of observations that are in the
tail. This heightened sensitivity could be disruptive to a fund's
portfolio management in the context of the final rule because it could
result in large changes in a fund's expected shortfall as outlier
losses enter and exit the observations that are in the tail or that are
used to model the tail's distribution.
---------------------------------------------------------------------------

    \974\ See supra section II.D.1.
---------------------------------------------------------------------------

    A limit on fund leverage risk based on stressed VaR or expected
shortfall also would likely be less effective at limiting fund leverage
risk during normal conditions and protecting investors from losses
resulting from less extreme scenarios. Conversely, the final rule's
outside limit on fund leverage risk using VaR is complemented by
elements in the final rule's derivatives risk management program, such
as the stress testing requirement, designed to address VaR's
limitations, including that VaR does not capture tail risk. Finally, as
VaR is commonly used, we do not believe that stressed VaR or expected
shortfall would be cheaper to implement for funds than the final rule's
VaR-based tests.
f. Funds Limited to Certain Investors
    The final rule does not provide an exemption from the rule's VaR-
based limit for funds that limit their investors to ``qualified
clients,'' as defined in rule 205-3 under the Advisers Act, and/or are
sold exclusively to ``qualified clients,'' ``accredited investors,'' or
``qualified purchasers.'' \975\ Some commenters suggested that the
Commission exempt these funds from the rule's VaR limits.\976\
---------------------------------------------------------------------------

    \975\ See supra footnote 415.
    \976\ See supra footnote 416.
---------------------------------------------------------------------------

    We believe that the benefits and costs to investors and funds of
the final rule's VaR-based limit on fund leverage risk, as discussed in
this economic analysis, generally apply similarly across the various
types of funds that will be subject to the final rule.\977\ However,
the investor protection benefits may be attenuated for some more
sophisticated investors, to the extent that these investors would
prefer to invest in fund strategies that will not be possible under the
final rule's VaR limits and that they fully understand the potential
for losses in such funds.\978\ As discussed above, however, to the
extent that a fund limits its investor base as described by these
commenters is able to qualify for the exclusions from the investment
company definition in section 3(c)(1) or 3(c)(7), the fund can operate
as a private fund under those exclusions and will not be subject to
section 18. Where a fund does operate as registered investment company
or BDC, however, we do not believe that the potentially attenuated
benefits to some more sophisticated investors would justify the final
rule exempting funds that limit their investor base from the final
rule's VaR-based limit on fund leverage risk.
---------------------------------------------------------------------------

    \977\ See supra section III.C.2.
    \978\ Investors that meet certain asset holdings and income
requirements and thus are presumed sophisticated have the ability to
invest in unregistered funds that pursue complex derivatives
strategies with significant leverage, and these funds are not
subject to the requirements of rule 18f-4.
---------------------------------------------------------------------------

g. No Modification of VaR Limits for Certain Closed-End Funds
    The final rule provides higher VaR limits for closed-end funds that
have then-outstanding shares of preferred stock issued to investors,
compared to open-end funds. Specifically, the relative VaR limit for
these closed-end funds is increased from 200% to 250% of the VaR of the
fund's designated reference portfolio and the absolute VaR limit is
increased from 20% to 25% of the fund's assets. As an alternative, we
considered requiring all funds that are subject to the relative or
absolute VaR test to adhere to the same limits of 200% of the VaR of
the fund's designated reference portfolio or 20% of the fund's assets,
respectively.
    As suggested by commenters, providing the same relative and
absolute VaR limit for open-end funds and closed-end funds does not
incorporate

the fact that closed-end funds that have preferred stock outstanding
may have a higher starting VaR than open-end funds. That is, even
before entering into any derivatives transactions, such closed-end
fund's VaR could be higher than an open-end fund's VaR attributable to
the structural leverage obtained through the issuance of preferred
stock, which section 18 of the Investment Company Act permits closed-
end funds but not open-end funds to issue.\979\ As a result, investors
may expect closed-end funds to have a higher VaR level. In addition,
some closed-end funds could potentially have no or limited flexibility
to enter into derivatives transactions if we required them comply with
the same VaR limits as open-end funds, which could limit investor
choice and impose costs on such funds.
---------------------------------------------------------------------------

    \979\ See supra sections II.D.2.c.ii and II.D.3.
---------------------------------------------------------------------------

2. Alternatives to the VaR Tests
a. Stress Testing
    As an alternative to the final rule's VaR-based limit on fund
leverage risk, we considered establishing an outside limit on fund
leverage risk using a stress testing approach. We understand that many
funds that use derivatives transactions already conduct stress testing
for purposes of risk management, and the final rule likewise provides
that funds required to establish a derivatives risk management program
must conduct stress testing.\980\ However, we do not believe that a
stress testing approach would impose significantly lower costs on funds
compared to a VaR-based approach, with the exception of those funds
that already conduct stress testing but not VaR testing.\981\
---------------------------------------------------------------------------

    \980\ See also Proposing Release, supra footnote 1, at section
II.D.6.a.
    \981\ See also 2019 ICI Comment Letter (stating that,
``depending on the type of fund managed and whether the fund
currently employs the test for risk management purposes, some
respondents viewed a stress loss test as being more burdensome to
implement, while others viewed a VaR test as being more burdensome
to implement.'').
---------------------------------------------------------------------------

    It would be challenging for the Commission to specify a set of
asset class shocks, their corresponding shock levels, and, in the case
of multi-factor stress testing, assumptions about the correlations of
the shocks, in a manner that applies to all funds and does not become
stale over time. While we could also prescribe a principles-based
stress testing requirement, we believe that the flexibility such an
approach would give to individual funds over how to implement the test
would render it less effective than the final rule's VaR test at
establishing an outer limit on fund leverage risk.
    Finally, stress testing generally focuses on a narrower and more
remote range of extreme loss events compared to VaR analysis. As a
result, a limit on fund leverage risk based on stress testing would
likely be less effective at limiting fund leverage risk during normal
conditions and protecting investors from losses resulting from less
extreme scenarios.
b. Asset Segregation
    As another alternative, we considered an asset segregation approach
in lieu of the final rule's VaR-based limit on fund leverage risk. For
example, we considered an approach similar to the Commission's position
in Release 10666, under which a fund engaging in derivatives
transactions would segregate cash and cash equivalents equal in value
to the full amount of the conditional and unconditional obligations
incurred by the fund (also referred to as ``notional amount
segregation'').\982\ Such an approach could also permit a fund to
segregate a broader range of assets, subject to haircuts.\983\
Alternatively, we could require funds to segregate liquid assets in an
amount equal to the fund's daily mark-to-market liability plus a
``cushion amount'' designed to address potential future losses.
---------------------------------------------------------------------------

    \982\ See also Direxion Comment Letter (suggesting that the
Commission ``codify existing asset segregation practices'')
    \983\ The 2016 DERA Memo, for example, analyzed different risk-
based ``haircuts'' that could apply to a broader range of assets.
See, e.g., 2016 DERA Memo, supra footnote 5.
---------------------------------------------------------------------------

    We believe that asset segregation approaches have several drawbacks
as a means for limiting fund leverage risk, compared to the final
rule's VaR tests.\984\ For example, notional amount segregation is not
risk-sensitive and could restrict derivatives transactions that would
reduce portfolio risk. Similarly, segregation of liquid assets in an
amount equal to the fund's daily mark-to-market liability plus a
``cushion amount'' would be difficult to implement in a manner that is
applied uniformly across all funds and types of derivatives. In
addition, asset segregation approaches raise certain compliance
complexities that may not make them significantly less costly to
implement for funds than the VaR tests.\985\
---------------------------------------------------------------------------

    \984\ As discussed above, as a result of current asset
segregation practices, funds' derivatives use--and thus funds'
potential leverage through derivatives transactions--does not appear
to be subject to a practical limit as the Commission contemplated in
Release 10666. See supra section I.B.3. Funds' current asset
segregation practices also may not assure the availability of
adequate assets to meet funds' derivatives obligations. Id. Several
commenters stated that an asset segregation regime may not be an
effective means of addressing undue speculation concerns. See supra
footnote 308 and accompanying text.
    \985\ See Proposing Release, supra footnote 1, at section
II.D.6.b.
---------------------------------------------------------------------------

    In conjunction with the final rule's VaR-based limit, we also
considered requiring a fund that relies on the final rule to maintain
an amount of ``qualifying coverage assets'' designed to enable a fund
to meet its derivatives-related obligations. However, we believe that
the final rule's requirements, including the requirements that funds
establish derivatives risk management programs and comply with the
rule's VaR-based limit on fund leverage risk, will address the risk
that a fund may be required to realize trading losses by selling its
investments to generate cash to pay derivatives counterparties.\986\
---------------------------------------------------------------------------

    \986\ See supra footnote 305 and accompanying text.
---------------------------------------------------------------------------

    Some commenters suggested that we adopt narrower asset segregation
approaches with regard to only certain kinds of transactions. For
example, some commenters suggested that we adopt an asset segregation
approach for firm and standby commitment agreements that do not satisfy
the conditions in the delayed-settlement securities provision.\987\
However, these transactions involve many of the same kinds of risks as
other derivatives instruments that are considered derivatives
transactions under the rule and will therefore be included in the final
rule's definition of ``derivatives transactions''. Some commenters also
suggested that we adopt an asset segregation approach for reverse
repurchase agreements.\988\ These transactions can be used to introduce
leverage into a fund's portfolio just like other forms of borrowings,
or derivatives.\989\ Accordingly, the final rule permits a fund either
to limit its reverse repurchase and other similar financing transaction
activity to the applicable asset coverage limit of the Act for senior
securities representing indebtedness, or, instead, to treat them as
derivative transactions. Compared to these alternatives, we believe
that the final rule will protect investors more effectively, because it
provides a consistent set of requirements for funds engaging in
economically similar transactions.
---------------------------------------------------------------------------

    \987\ See supra footnote 112 and accompanying text for a
discussion of commenter's suggestions related to this alternative.
    \988\ See supra footnotes 722-725 and accompanying text.
    \989\ See supra section III.C.4.

---------------------------------------------------------------------------

c. Exposure-Based Test
    We alternatively considered an exposure-based approach for limiting
fund leverage risk in lieu of the final rule's VaR test, as one
commenter suggested.\990\ An exposure-based test could limit a fund's
derivatives exposure, as defined in the rule, to a specified percentage
of the fund's net assets. For example, we considered requiring that a
fund limit its derivatives exposure to 50% of net assets, to match the
amount an open-end could borrow from a bank, or 100% of net assets to
match a level of gross market exposure that generally would satisfy the
relative VaR test. A similar approach would be to provide that the sum
of a fund's derivatives exposure and the value of its other investments
cannot exceed 150% or 200% of its net asset value. This latter
approach, and particularly if cash and cash equivalents were not
included in the calculation, would allow a fund to achieve the level of
market exposure permitted for an open-end fund under section 18 using
any combination of derivatives and other investments, or likewise to
achieve a level of gross market exposure that generally would satisfy
the relative VaR test.
---------------------------------------------------------------------------

    \990\ See supra footnotes 303-304 and accompanying text for a
discussion of comments we received on using an exposure-based
approach to limiting fund leverage risk.
---------------------------------------------------------------------------

    While an exposure-based test may be simpler and therefore less
costly to implement for the typical fund than the VaR tests, an
exposure-based test has certain limitations compared to VaR tests. One
limitation is that measuring derivatives exposure based on notional
amounts would not reflect how derivatives are used in a portfolio,
whether to hedge or gain leverage, nor would it differentiate
derivatives with different risk profiles. Various adjustments to the
notional amount are available that may better reflect the risk
associated with the derivatives transactions, although even with these
adjustments the measure would remain relatively blunt. For example, an
exposure-based limit could significantly limit certain strategies that
rely on derivatives more extensively but that do not seek to take on
significant leverage risk.
    Some of the limitations of an exposure-based approach could be
addressed if rule 18f-4 were to provide an exposure-based test as an
optional alternative to the VaR tests, rather than as the sole means of
limiting fund leverage risk. Under this second alternative, funds with
less complex portfolios might choose to rely on an exposure-based test
if this would lead to lower compliance costs than the VaR tests. If we
provided that the sum of a fund's derivatives exposure and the value of
its other investments cannot exceed 200% of its net asset value, funds
below this threshold would generally also pass the relative VaR test.
Conversely, funds with more complex portfolios that rely on derivatives
more extensively but that do not seek to take on significant leverage
risk might choose to rely on the VaR test. As the final rule will
already except limited derivatives users from the VaR-based limit on
fund leverage risk, however, we do not believe that also giving funds
the option of relying on an exposure-based limit on fund leverage risk
would be necessary or that it would significantly reduce the compliance
burden associated with the final rule.
3. Stress Testing Frequency
    Rule 18f-4 will require funds that enter into derivatives
transactions and are not limited derivatives users to adopt and
implement a derivatives risk management program that includes stress
testing, among other elements. The final rule will permit a fund to
determine the frequency of stress tests, provided that the fund must
conduct stress testing at least weekly.\991\
---------------------------------------------------------------------------

    \991\ See supra section II.B.2.c for a discussion of comments we
received on this aspect of the proposal.
---------------------------------------------------------------------------

    As an alternative to the weekly requirement, we considered both
shorter and longer minimum stress testing frequencies.\992\ On the one
hand, more frequent stress testing would reflect changes in risk for
fund strategies that involve frequent and significant portfolio
turnover as well as increases in market stress in a timelier manner
compared to less frequent stress testing. On the other hand, given the
forward-looking nature of stress testing, we expect that most funds
would take foreseeable changes in market conditions and portfolio
composition into account when conducting stress testing. More-frequent
stress testing also may impose an increased cost burden on funds,
compared to less frequent stress testing, although we would expect any
additional cost burden to be small, to the extent that funds perform
stress testing in an automated manner. Overall, we believe that the
final rule's requirement for stress testing at least weekly
appropriately balances the anticipated benefits of relatively frequent
stress testing against the burdens of administering stress testing. In
addition, some commenters said that a weekly stress-testing frequency
is consistent with many fund's current practices.\993\
---------------------------------------------------------------------------

    \992\ See supra section II.B.2.c for a discussion of the comment
letters that addressed this aspect of the proposal.
    \993\ See J.P. Morgan Comment Letter; Better Markets Comment
Letter.
---------------------------------------------------------------------------

    Another alternative would be to permit a fund to determine its own
stress testing frequency without the final rule prescribing a minimum
stress testing frequency. This approach would provide maximum
flexibility to funds regarding the frequency of their stress tests, and
would reduce compliance costs for funds that determine that stress
testing less frequently than weekly is warranted in light of their own
particular facts and circumstances. However, allowing funds
individually to determine the frequency with which stress tests are
conducted could result in some funds stress testing their portfolios
too infrequently to provide timely information to the fund's
derivatives risk manager and board. Taking these considerations into
account, we are requiring weekly stress tests, rather than less-
frequent testing, to provide for consistent and reasonably frequent
stress testing by all funds that will be required to establish a
derivatives risk management program.
4. Enhanced Disclosure
    As an alternative to the requirements in rule 18f-4, such as the
derivatives risk management program and the VaR-based limit on fund
leverage risk, we could consider addressing the risks associated with
funds' use of derivatives through enhanced disclosures to investors
with respect to a fund's use of derivatives and the resulting
derivatives-related risks.\994\ While an approach focused on enhanced
disclosures could result in greater fund investment flexibility, we
believe that such an approach would be less effective than the final
rule in addressing the purposes and concerns underlying section 18 of
the Investment Company Act. Section 18 itself imposes a specific limit
on the amount of senior securities that a fund may issue, regardless of
the level of risk introduced or the disclosure that a fund provides
regarding those risks. Absent additional requirements to limit leverage
or potential leverage, requiring enhancement to derivatives disclosure
alone would not appear to provide any limit on the amount of leverage
or leverage risk a fund may obtain. Indeed,

the degree to which funds use derivatives varies widely between funds.
As a result, an approach focused solely on enhanced disclosure
requirements may not provide a sufficient basis for an exemption from
the requirements of section 18 of the Investment Company Act.
---------------------------------------------------------------------------

    \994\ See, e.g., Comment Letter of the Fixed Income Market
Structure Advisory Committee on proposed rule 6c-11 under the
Investment Company Act (Oct. 29, 2018) (recommending that the
Commission consider future rulemaking regarding ``leveraged ETP''
investor disclosure requirements).
---------------------------------------------------------------------------

5. Alternative Treatment for Leveraged/Inverse Funds
    Under the final rule, leveraged/inverse funds generally will be
subject to the requirements of rule 18f-4 on the same basis as other
funds that are subject to that rule, including the VaR-based leverage
risk limit. The rule will, however, permit currently operating
leveraged/inverse funds that seek to provide leveraged or inverse
market exposure exceeding 200% of the return or inverse return of the
relevant index that cannot satisfy the VaR-based leverage limit to
continue operating at their current leverage levels, provided they meet
certain requirements.\995\ As an alternative, we could omit the
requirement for leveraged/inverse funds to comply with the VaR-based
leverage limit and instead limit these funds to, for example, obtaining
300% of the performance or inverse performance of the relevant index
and adopt the proposed sales practices rules, which would have required
a broker-dealer or investment adviser to exercise due diligence in
approving a retail investor's account to invest in leveraged/inverse
investment vehicles.\996\
---------------------------------------------------------------------------

    \995\ This exception is limited to funds currently in operation,
and would therefore not allow a fund sponsor to launch a new
leveraged/inverse fund that exceeds this exposure limit.
    \996\ As defined in the proposed sales practices rules,
leveraged/inverse investment vehicles include leveraged/inverse
funds and certain exchange-listed commodity- or currency-based
trusts or funds that use a similar leveraged/inverse strategy. (See
Proposing Release, supra footnote 1, at section II.G.2.) The
provision of rule 18f-4 that provides an exception from the VaR-
based limit on fund leverage risk for certain leveraged/inverse
funds currently in operation with leverage or inverse multiples
exceeding 200% is only available to such a fund if it does not
increase the level of leveraged or inverse market exposure that it
seeks, directly or indirectly, to provide. This provision
effectively limits these funds from operating with a leverage or
inverse multiple exceeding 300%, as the Commission proposed for
leveraged/inverse funds generally. The alternative considered in
this section also includes such a requirement and therefore does not
differ from the final rule in this respect. The Proposing Release
discussed the effects of alternative exposure limits for leveraged/
inverse funds. (See Proposing Release, supra footnote 1, at section
III.E.4.)
---------------------------------------------------------------------------

    All existing leveraged/inverse funds will be able to continue
operating under the final rule; this also would be the case under the
alternative. However, the final rule and the alternative have different
implications for the ability of fund sponsors to offer new leveraged/
inverse funds. While fund sponsors will be able to launch new funds
with exposures up to 200% under the final rule, as they would under the
alternative, the final rule will prevent fund sponsors from offering
new funds with market exposure exceeding 200% that cannot satisfy the
final rule's relative VaR test.
    As we discussed in the Proposing Release, broker-dealers and
investment advisers would incur direct compliance costs associated with
implementing due diligence and account approval requirements under the
alternative.\997\ Commenters also expressed concerns regarding
potential legal liability for broker-dealers and investment advisers
associated with implementing the requirements under the proposed sales
practices rules.\998\
---------------------------------------------------------------------------

    \997\ See Proposing Release, supra footnote 1, at section
III.C.5.
    \998\ See supra footnote 582.
---------------------------------------------------------------------------

    The alternative also would impose a burden on investors to access
leveraged/inverse investment vehicles, including on those investors
that understand the risks of these products. Some leveraged/inverse
investment vehicles may lose existing or potential investors as a
result of some retail investors not being approved by their broker-
dealer or investment adviser to transact in leveraged/inverse
investment vehicles.\999\ This could lead to fewer leveraged/inverse
investment vehicles being available to investors who would be approved
to transact in these vehicles and decreased competition among these
products.\1000\ However, the final rule may also lead to a reduction in
investor choice and competition for some leveraged/inverse investment
vehicles. Specifically, because the rule limits the exception from the
final rule's VaR-based limit on fund leverage risk to certain
leveraged/inverse funds currently in operation, the number of
leveraged/inverse funds exceeding this limit may fall under the final
rule.\1001\
---------------------------------------------------------------------------

    \999\ See, e.g., Americans for Limited Government Comment
Letter; Direxion Comment Letter; ProShares Comment Letter; Schwab
Comment Letter.
    \1000\ See also Flannery Comment Letter, supra footnote 901
(stating that the proposed sales practices rules could lead to
reduced demand for leveraged/inverse funds and make offering them
economically unviable); and Proposing Release, supra footnote 1, at
section III.D.2.
    \1001\ See supra sections III.C.5 and III.D.2.
---------------------------------------------------------------------------

    The alternative may have increased benefits for investor
protection, to the extent that account approval requirements that are
specific to leveraged/inverse investment vehicles, which are in
addition to advisers' and broker-dealers' existing requirements and
practices, are effective at helping ensure that investors in these
products are limited to those who are capable of evaluating their
risks.\1002\ The proposed sales practices rules would not have covered
all products that offer leveraged or inverse exposures to an index,
however, and some of those substitute products may present additional
risks. For example, as one commenter stated, some investors could
choose to invest in ETNs, which would not have been covered by the
proposed sales practices rules and which are subject to issuer default,
potentially hampering the effectiveness of the alternative to improve
investor protection.\1003\
---------------------------------------------------------------------------

    \1002\ Neither Regulation Best Interest nor investment advisers'
fiduciary obligations apply to investments in leveraged/inverse
investment vehicles by self-directed retail investors.
    \1003\ See Flannery Comment Letter, supra footnote 901.
---------------------------------------------------------------------------

    As another alternative, we considered placing additional
disclosure-based requirements on intermediaries offering leveraged/
inverse investment vehicles to retail investors, as suggested by some
commenters.\1004\ For example, some commenters suggested we require
broker-dealers to: (1) Provide their self-directed customers with
short, plain-English disclosures of the potential risks of trading
leveraged/inverse investment vehicles, both at the point of sale and
periodically thereafter; and (2) require such customers to provide an
acknowledgement of receipt of these disclosures.\1005\ Similar to the
proposed sales practices rules, this alternative could have investor
protection benefits, to the extent that these disclosures would be
effective at helping ensure that investors in these products are
limited to those who are capable of evaluating their risks. At the same
time, this alternative would also impose costs on the intermediaries
that would be required to implement the requirement and would impose a
burden on investors to access leveraged/inverse investment vehicles,
including on those investors that understand the risks of these
products.
---------------------------------------------------------------------------

    \1004\ See, e.g., Direxion Comment Letter; Schwab Comment
Letter.
    \1005\ See, e.g., Schwab Comment Letter; TD Ameritrade Comment
Letter.
---------------------------------------------------------------------------

    As another alternative, we considered requiring all leveraged/
inverse funds to comply with the final rule's VaR-based leverage limit.
Compared to the final rule, this alternative would therefore not permit
any currently operating leveraged/inverse funds that seek to provide
leveraged or inverse market exposure exceeding 200% of the return or
inverse return of the relevant index that cannot satisfy the VaR-based

leverage limit to continue operating at their current leverage levels.
This alternative would protect investors who may not be capable of
evaluating the risks associated with leveraged/inverse funds that
cannot satisfy the rule's VaR based leverage limit. At the same time,
this alternative would restrict investor choice for investors who are
capable of evaluating the risks associated with these funds and would
impose a cost on these funds by requiring them to either stop operating
or change their investment objectives.
    In light of these considerations and the staff review of the
effectiveness of the existing regulatory requirements in protecting
investors in leveraged/inverse and other complex investment products,
we are not adopting the proposed sales practices rules or any of the
other alternatives discussed in this section at this time.

IV. Paperwork Reduction Act Analysis

A. Introduction

    Rule 18f-4 will result in new ``collection of information''
requirements within the meaning of the Paperwork Reduction Act of 1995
(``PRA'').\1006\ In addition, the amendments to rules 6c-11 and 30b1-10
under the Investment Company Act, as well as to Forms N-PORT, Form N-
LIQUID (which will be re-titled Form N-RN), and N-CEN will affect the
collection of information burden under those rules and forms.\1007\
---------------------------------------------------------------------------

    \1006\ 44 U.S.C. 3501-3520.
    \1007\ We do not believe that the final conforming amendment to
Form N-2, to reflect a clarification that funds do not have to
disclose in their senior securities table the derivatives
transactions and unfunded commitment agreements entered into in
reliance on rule 18f-4, makes any new substantive recordkeeping or
information collection within the meaning of the PRA. The Commission
stated this view in the Proposing Release and did not receive any
comments regarding any burden and cost estimates to Form N 2.
Accordingly, we do not revise any burden and cost estimates in
connection with this amendment.
    Similarly, we do not believe that the final conforming
amendments to rule 22e-4 and Form N-PORT, to remove references to
assets ``segregated to cover'' derivatives transactions in the rule
and form and to amend the Form N-PORT general instructions to
clarify the term ``derivatives transaction'' in light of the
adoption of rule 18f-4, result in any new substantive recordkeeping
or information collection within the meaning of the PRA.
Accordingly, we do not revise any burden and cost estimates in
connection with these amendments.
---------------------------------------------------------------------------

    The titles for the existing collections of information are: ``Form
N-PORT'' (OMB Control No. 3235-0731); ``Rule 30b1-10 and Form N-
LIQUID'' (OMB Control No. 3235-0754); ``Form N-CEN'' (OMB Control No.
3235-0730); and ``Rule 6c-11 under the Investment Company Act of 1940,
Exchange-traded funds'' (OMB Control No. 3235-0764). The title for the
new collection of information will be: ``Rule 18f-4 under the
Investment Company Act of 1940, Use of Derivatives by Registered
Investment Companies and Business Development Companies.'' The
Commission is submitting these collections of information to the Office
of Management and Budget (``OMB'') for review in accordance with 44
U.S.C. 3507(d) and 5 CFR 1320.11. An agency may not conduct or sponsor,
and a person is not required to respond to, a collection of information
unless it displays a currently-valid control number.

B. Rule 18f-4

    Rule 18f-4 permits a fund to enter into derivatives transactions,
notwithstanding the prohibitions and restrictions on the issuance of
senior securities under section 18 of the Investment Company Act.
    A fund that relies on rule 18f-4 to enter into derivatives
transactions generally will be required to: Adopt a derivatives risk
management program; have its board of directors approve the fund's
designation of a derivatives risk manager and receive direct reports
from the derivatives risk manager about the derivatives risk management
program; and comply with a VaR-based test designed to limit a fund's
leverage risk consistent with the investor protection purposes
underlying section 18. Rule 18f-4 includes an exception from the
derivatives risk management program requirement and limit on fund
leverage risk if a fund limits its derivatives exposure to 10% of its
net assets (the fund may exclude from this calculation derivatives
transactions that it uses to hedge certain currency and interest rate
risks). A fund relying on this exception will be required to adopt
policies and procedures that are reasonably designed to manage its
derivatives risks.
    Rule 18f-4 also includes an exception from the VaR-based limit on
leverage risk for a leveraged/inverse fund that cannot comply with rule
18f-4's limit on fund leverage risk and that, as of October 28, 2020,
is: (1) In operation, (2) has outstanding shares issued in one or more
public offerings to investors, and (3) discloses in its prospectus that
it has a leverage multiple or inverse multiple that exceeds 200% of the
performance or the inverse of the performance of the underlying index.
A fund relying on this exception must disclose in its prospectus that
it is not subject to rule 18f-4's limit on fund leverage risk.\1008\
Rule 18f-4 also requires a fund to meet certain recordkeeping
requirements that are designed to provide the Commission, and the
fund's board of directors and compliance personnel, the ability to
evaluate the fund's compliance with the rule's requirements. Finally,
rule 18f-4 includes provisions that will permit funds to enter into
reverse repurchase agreements (and similar financing transactions) and
``unfunded commitments'' to make certain loans or investments, and to
invest in securities on a when-issued or forward-settling basis, or
with a non-standard settlement cycle, subject to conditions tailored to
these transactions.
---------------------------------------------------------------------------

    \1008\ See rule 18f-4(c)(5)(iii); supra section II.F.2.
---------------------------------------------------------------------------

    The purpose of rule 18f-4 is to address the investor protection
purposes and concerns underlying section 18 of the Act and to provide
an updated and more comprehensive approach to the regulation of funds'
use of derivatives and the other transactions addressed in the rule.
The respondents to rule 18f-4 will be registered open- and closed-end
management investment companies and BDCs.\1009\ We estimate that 5,203
funds will likely rely on rule 18f-4.\1010\ Compliance with rule 18f-4
will be mandatory for all funds that seek to engage, in reliance on the
rule, in derivatives transactions and certain other transactions that
the rule addresses, which would otherwise be subject to the
restrictions of section 18. To the extent that records required to be
created and maintained by funds under the rule are provided to the
Commission in connection with examinations or

investigations, such information will be kept confidential subject to
the provisions of applicable law.
---------------------------------------------------------------------------

    \1009\ See rule 18f-4(a) (defining ``fund'').
    \1010\ We estimate this number as follows: 2,766 funds that will
be subject to the derivatives risk management program requirement +
2,437 funds relying on the limited derivatives user exception and
complying with the related limited derivatives user requirements =
5,203 funds. See supra text accompanying footnote 849 (estimated
number of funds subject to the derivatives risk management program
requirement), and supra paragraph following footnote 892 (estimated
number of funds that will qualify as limited derivatives users).
    The Commission's estimates of the relevant wage rates for
internal time costs in the tables below are based on salary
information for the securities industry compiled by the Securities
Industry and Financial Markets Association's Office Salaries in the
Securities Industry 2013. The estimated wage figures are modified by
Commission staff to account for an 1,800-hour work-year and
multiplied by 5.35 to account for bonuses, firm size, employee
benefits, overhead, and adjusted to account for the effects of
inflation. See Securities Industry and Financial Markets
Association, Report on Management & Professional Earnings in the
Securities Industry 2013 (``SIFMA Report''). These wage figures
differ slightly from the same figures the Commission used in its
estimates in the Proposing Release to account for incremental
inflation effects. The Commission's estimates of the relevant wage
rates for external time costs, such as outside legal services, takes
into account staff experience, a variety of sources including
general information websites, and adjustments for inflation.
---------------------------------------------------------------------------

1. Derivatives Risk Management Program
    Rule 18f-4 requires certain funds relying on the rule to adopt and
implement a written derivatives risk management program, which includes
policies and procedures reasonably designed to manage the fund's
derivatives risks and a periodic review requirement.\1011\ We estimate
that 2,766 funds will be subject to the program requirement.\1012\
---------------------------------------------------------------------------

    \1011\ See rule 18f-4(c)(1); supra section II.B (discussing the
derivatives risk management program requirements).
    \1012\ See supra sentence following footnote 882. A fund that is
a limited derivatives user will not be required to comply with the
program requirement. Funds that are limited derivatives users will
be required to adopt policies and procedures that are reasonably
designed to manage their derivatives risks. See rule 18f-4(c)(4);
infra section IV.B.6 (discussing collections of information related
to limited derivatives users).
---------------------------------------------------------------------------

    Table 1 below summarizes the initial and ongoing annual burden
estimates associated with the derivatives risk management program
requirement under rule 18f-4 as adopted. While the Commission did not
receive any comments specifically addressing the estimated PRA burdens
in the Proposing Release associated with the derivatives risk
management program, it did receive comments suggesting that the
implementation of the program, including the associated collections of
information as defined in the PRA, may be more burdensome than the
Commission estimated at proposal.\1013\ As such, we have increased the
annual burden estimates associated with the derivatives risk management
program, as shown in Table 1 below.
---------------------------------------------------------------------------

    \1013\ See supra section II.B.
---------------------------------------------------------------------------

BILLING CODE 8011-01-P

[GRAPHIC] [TIFF OMITTED] TR21DE20.000

2. Board Oversight and Reporting
    Rule 18f-4 requires: (1) A fund's board of directors to approve the
designation of the fund's derivatives risk manager, (2) the derivatives
risk manager to provide certain written reports to the board.\1014\ We
estimate that 2,766 funds will be subject to these requirements.\1015\
---------------------------------------------------------------------------

    \1014\ See rule 18f-4(c)(3)(i) through (iii); supra section
II.C. Burdens associated with reports to the fund's board of
directors of material risks arising from the fund's derivatives
transactions, as described in rule 18f-4(c)(1)(v), are discussed
above in supra section IV.B.1.
    \1015\ See supra footnotes 849, 1010 and accompanying text.
---------------------------------------------------------------------------

    Table 2 below summarizes the initial and ongoing annual burden
estimates associated with the board oversight and reporting
requirements under rule 18f-4. While the Commission did not receive any
comments specifically addressing the estimated PRA burdens in the
Proposing Release associated with the board oversight and reporting
requirements, it did receive comments suggesting that requiring the
fund's board of directors to approve the designation of the fund's
derivatives risk manager would place increased burdens on the fund's
board of directors.\1016\ Accordingly, we have adjusted the proposal's
estimated annual burden hours and total time costs to account for the
potential for increased time burdens on the board of directors and to
reflect the Commission's updated views on typical time burdens
associated with similar board reporting requirements in other
Commission regulations.
---------------------------------------------------------------------------

    \1016\ See Dechert Comment Letter I; IDC Comment Letter; see
also supra section II.C.1.

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[GRAPHIC] [TIFF OMITTED] TR21DE20.001

3. VaR Remediation
    Rule 18f-4 requires that if a fund is not in compliance within five
business days, following an exceedance of the VaR-based fund leverage
limit, the derivatives risk manager must provide certain written
reports to the fund's board.\1017\ In contrast, the proposed rule would
have required the derivatives risk manager to notify the fund's board
(and would not have specifically required a written report for such
notification) following the fund being out of compliance with the VaR-
based fund leverage limit for three business days.\1018\
---------------------------------------------------------------------------

    \1017\ See rule 18f-4(c)(2)(ii)(A) through (C); supra section
II.D.6.b.
    \1018\ See supra section II.D.6.b.
---------------------------------------------------------------------------

    Table 3 below summarizes the initial and ongoing annual burden
estimates associated with the VaR-related remediation reports required
under rule 18f-4. For purposes of the PRA analysis, we do not estimate
that there will be any initial or ongoing external costs associated
with the VaR-related remediation requirements.

[GRAPHIC] [TIFF OMITTED] TR21DE20.002

4. Disclosure Requirement for Certain Leveraged/Inverse Funds
    Under the final rule, an over-200% leveraged/inverse fund currently
in operation will not have to comply with the VaR-based leverage risk
limit. Such a fund is required to disclose in its prospectus that it is
not subject to rule 18f-4's limit on fund leverage risk.\1019\ This
requirement represents a change from the proposal, in which we proposed
to require that all leveraged/inverse funds (i.e., not only those with
a leverage or inverse multiple above 200% of the underlying index)
disclose that they are not subject to the rule's VaR-based leverage
risk limit. As such, whereas in the proposal the Commission estimated
that 269 leveraged/inverse funds would be subject to this prospectus
disclosure requirement, we now estimate that 70 over-200% leveraged/
inverse funds will be subject to this requirement.\1020\
    Table 4 below summarizes the initial and ongoing annual burden
estimates associated with the rule's disclosure requirement for over-
200% leveraged/inverse funds. We do not estimate that there will be any
initial or ongoing external costs associated with this disclosure
requirement. The Commission did not receive any comments relating to
the estimated PRA burdens set forth in the Proposing Release associated
with the prospectus disclosure requirement for leveraged/inverse
funds.\1021\ As shown in Table 4 below, we are making a modest increase
to the estimated per-fund burden associated with the prospectus
disclosure requirement for over-200% leveraged/inverse funds to reflect
updated views on the burdens related to similar prospectus disclosure
requirements.
---------------------------------------------------------------------------

    \1019\ See rule 18f-4(c)(5)(iii); supra section II.F.
    \1020\ See supra paragraph accompanying footnote 819 (estimating
70 leveraged/inverse ETFs (and 0 leveraged/inverse mutual funds)
that currently seek to provide leveraged or inverse market exposure
exceeding 200% of the return or inverse return of the relevant
index).
    \1021\ See supra footnote 612 and accompanying text (discussing
comment received on proposed prospectus disclosure requirement
generally).

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[GRAPHIC] [TIFF OMITTED] TR21DE20.003

5. Disclosure Changes for Money Market Funds
    In a change from the proposal, the final rule includes a provision
that will permit money market funds to invest in securities on a when-
issued or forward-settling basis, or with a non-standard settlement
cycle (``delayed-settlement securities provision''). As in the
proposal, money market funds are excluded from the full scope of the
final rule because they do not typically enter into derivatives
transactions, as defined in the rule.\1022\ To the extent a money
market fund currently discloses in its prospectus that it may enter
into transactions covered by the final rule other than transactions
covered by the delayed-settlement securities provision, money market
funds will be subject to the burdens associated with making disclosure
changes to their prospectuses. We estimate that 420 funds could be
subject to such disclosure changes.\1023\
---------------------------------------------------------------------------

    \1022\ See rule 18f-4(a) (defining the term ``Fund'' to ``. .
.not include a registered open-end company that is regulated as a
money market fund'').
    \1023\ See supra footnote 804 and accompanying text. This likely
overestimates the total number of funds subject to these disclosure
changes, because we believe that money market funds currently do not
typically engage in derivatives transactions.
---------------------------------------------------------------------------

    Table 5 below summarizes the initial and ongoing annual burden
estimates associated with disclosure changes that money market funds
could make because of rule 18f-4. For purposes of this PRA analysis, we
do not estimate that there will be any initial or ongoing external
costs associated with this disclosure change requirement. The
Commission did not receive any comments relating to the estimated PRA
burdens set forth in the Proposing Release associated with potential
disclosure changes for money market funds. However, we have adjusted
the proposal's estimated annual burden hours and total time costs to
reflect the Commission's updated views on typical time burdens
associated with similar disclosure requirements in other Commission
regulations.

[GRAPHIC] [TIFF OMITTED] TR21DE20.004

BILLING CODE 8011-01-C

6. Requirements for Limited Derivatives Users
    Rule 18f-4 will require funds relying on the limited derivatives
user provisions to adopt and implement written policies and procedures
reasonably designed to manage the fund's derivatives risks.\1024\ In
addition to the initial burden to document the policies and procedures,
we estimate that limited derivatives users will have an ongoing burden
associated with any review and revisions to their policies and
procedures to ensure that they are ``reasonably designed'' to manage
the fund's derivatives risks. Rule 18f-4 also requires that the adviser
for any limited derivatives user that exceeds the 10% derivatives
exposure threshold and does not reduce its exposure within five
business days, must provide a written report to the fund's board of
directors informing them whether the adviser intends to reduce the
exposure promptly, but within no more than 30 days of the exceedance,
or put in place a derivatives risk management program and comply with
the VaR-based limit on fund leverage risk as soon as reasonably
practicable.\1025\ We estimate that 2,437 funds will be subject to
these limited derivatives users requirements.\1026\
---------------------------------------------------------------------------

    \1024\ See rule 18f-4(c)(4); supra section II.E.3 (discussing
the policies and procedures requirement for limited derivatives
users).
    \1025\ See rule 18f-4(c)(4)(ii); supra section II.E.4.
    \1026\ See supra paragraph following footnote 892.
---------------------------------------------------------------------------

    Table 6 below summarizes the initial and ongoing annual burden
estimates associated with the requirements for limited derivatives
users under rule 18f-4. The Commission did not receive comments
relating to the estimated hour and costs burdens associated with the
preparation and maintenance of a limited derivatives user's policies
and procedures. However, we have increased the proposal's estimated
burden hours and internal and external total time costs to account for
the potential that funds may implement additional policies and
procedures related to the changes we have incorporated into the final
rule to address exceedances of the 10% derivatives exposure threshold.
This increase also reflects the Commission's updated views on typical
time burdens and costs associated with the development of fund risk
management policies and procedures.
    Some commenters did state that many funds already have policies and
procedures in place to manage certain risks associated with their
derivatives transactions.\1027\ We do not have data to determine how
many funds currently have written policies and procedures in place that
will satisfy the rule's requirement. However, for purposes of our
estimated hour and costs burden, we assume that all limited derivatives
users will incur a cost associated with this requirement. Accordingly,
our estimate may be over-inclusive, to the extent that it counts funds
that already have in place policies and procedures reasonably designed
to manage the fund's derivatives risks. Our estimate also may be under-
inclusive, to the extent that it does not count funds that do not
currently use derivatives, but that might want to implement policies
and procedures reasonably designed to manage derivatives risks in order
to have future flexibility to engage in derivatives transactions under
the final's rule's limited derivatives user provision.
---------------------------------------------------------------------------

    \1027\ See Fidelity Comment Letter; IAA Comment Letter; see also
supra footnote 893 and accompanying paragraph (stating that the
Commission believes that ``these policies and procedures could be
readily adapted to meet the final rule's requirements without
significant additional cost'').
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BILLING CODE 8011-01-P

[GRAPHIC] [TIFF OMITTED] TR21DE20.005

[GRAPHIC] [TIFF OMITTED] TR21DE20.006

BILLING CODE 8011-01-C

7. Recordkeeping Requirements
    Rule 18f-4 will require a fund that enters into derivatives
transactions to maintain certain records. As proposed, if the fund is
not a limited derivatives user, the fund will be required to maintain
records related to the fund's derivatives risk management program and
the VaR-based limit on fund leverage risk, including records related to
board oversight and reporting (including records of the written
reporting that the rule requires to occur between the derivatives risk
manager and the fund's board when the fund is out of compliance with
the applicable VaR test).\1028\ As a modification to the proposal the
final rule includes further obligations for a fund that is out of
compliance with its applicable VaR test to provide written reports to
the board.\1029\ These additional reports will be covered by the final
recordkeeping requirements.
---------------------------------------------------------------------------

    \1028\ See rule 18f-4(c)(6)(i)(A) through (C).
    \1029\ See supra footnote 772 and accompanying text.
---------------------------------------------------------------------------

    If the fund is a limited derivatives user, the fund will be
required to maintain a written record of its policies and procedures
that are reasonably designed to manage derivatives risks.\1030\ As a
conforming change in the final rule, a limited derivatives user will
also be required to maintain records of written reports provided to the
board upon any exceedance by the fund of the 10% derivatives exposure
threshold, in accordance with the rule.\1031\
---------------------------------------------------------------------------

    \1030\ See rule 18f-4(c)(6)(i)(D).
    \1031\ Id.
---------------------------------------------------------------------------

    Further, in light of the final rule providing two separate
treatment options for a fund that enters into a reverse repurchase
agreement or similar financing transaction, we have conformed the
recordkeeping provision to require that a fund that enters into reverse
repurchase agreements or similar financing transactions to maintain a
written record documenting whether it is complying with the asset
coverage requirements of section 18 with respect to these transactions,
or alternatively whether it is treating these transactions as
derivatives transactions for all purposes under rule 18f-4.
    Finally, a fund engaging in unfunded commitment agreements will be
required to maintain records documenting the sufficiency of its cash
and cash equivalents to meet its obligations with respect to each
unfunded commitment agreement.\1032\
---------------------------------------------------------------------------

    \1032\ See rule 18f-4(e)(2).
---------------------------------------------------------------------------

    We estimate that 5,203 funds will be subject to recordkeeping
requirements under the final rule (although not all funds will be
subject to all of the rule's recordkeeping requirements).\1033\ Below
we estimate the average initial and ongoing annual burdens associated
with the recordkeeping requirements. This average takes into account
that some funds such as limited derivatives users may have less
extensive recordkeeping burdens than other funds that use derivatives,
or the other transactions that final rule 18f-4 addresses, more
substantially.
---------------------------------------------------------------------------

    \1033\ We estimate that the number of funds that will be subject
to the recordkeeping requirements includes the number of funds that
we estimate will be required to comply with the derivatives risk
management program requirement (2,766 funds, which number
encompasses the 2,696 funds that we estimate will be subject to the
VaR test requirements) and the number of funds that we estimate will
qualify as limited derivatives users (2,437 funds). See supra
footnote 1010 and sections III.C.1-III.C.3. 2,766 funds + 2,437
funds = 5,203 funds.
    Based on staff review of filings on Forms N-PORT and N-CEN for
2019, we estimate that 181 funds, or 1% of all funds subject to the
final rule, will enter into reverse repurchase agreements or similar
financing transactions (excluding BDCs, which we do not believe
enter into such transactions to a significant degree) and will be
subject to the recordkeeping requirements in the final rule. We
further estimate that approximately 8.5% of open-end funds, 30% of
registered closed-end funds, and 100% of BDCs, or 1,339 funds (10%
of all funds subject to the rule) will enter into unfunded
commitments and will incur be subject to the recordkeeping
requirements in the final rule. To prevent over-counting, we are not
adding these numbers of funds that engage in reverse repurchase
agreements and unfunded commitment agreements to the sum of 5,203
funds discussed above, because we assume that these funds generally
either would have to comply with the derivatives risk management
program requirement or would qualify as limited derivatives users.
---------------------------------------------------------------------------

    Table 7 below summarizes the proposed PRA estimates associated with
the recordkeeping requirements in rule 18f-4. The Commission did not
receive any comments related to the estimated PRA burdens set forth in
the Proposing Release associated with the rule's recordkeeping
requirements. However, we have adjusted the proposal's estimated annual
burden hours and total time costs, on account of the conforming
modifications to the proposed recordkeeping requirements that we are
adopting, as well as to reflect the Commission's updated views on
typical time burdens and personnel associated with similar
recordkeeping requirements in other Commission regulations.
BILLING CODE 8011-01-P

[GRAPHIC] [TIFF OMITTED] TR21DE20.007

[GRAPHIC] [TIFF OMITTED] TR21DE20.008

[GRAPHIC] [TIFF OMITTED] TR21DE20.009

8. Rule 18f-4 Total Estimated Burden
    As summarized in Table 8 below, we estimate that the total hour
burdens and time costs associated with rule 18f-4, amortized over three
years, will result in an average aggregate annual burden of 501,275
hours and an average aggregate annual monetized time cost of
$202,443,126. We also estimate that, amortized over three years, there
will be external costs of $22,252,947 associated with this collection
of information. Therefore, each fund that relies on the rule will incur
an average annual burden of approximately 96.34 hours, at an average
annual monetized time cost of approximately $38,909, and an external
cost of $4,277 to comply with rule 18f-4.\1034\
---------------------------------------------------------------------------

    \1034\ These per-fund burden estimates likely overestimate the
total burden of rule 18f-4 because not all funds (e.g., limited
derivatives users) would incur the various burdens set forth in the
table.

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[GRAPHIC] [TIFF OMITTED] TR21DE20.010

C. Rule 6c-11

    Rule 6c-11 permits ETFs that satisfy certain conditions to operate
without first obtaining an exemptive order from the Commission.\1035\
We are amending rule 6c-11 to permit leveraged/inverse ETFs to rely on
that rule, provided they satisfy the applicable requirements of rule
18f-4. Because we believe this amendment will increase the number of
funds relying on rule 6c-11, we are updating the PRA analysis for rule
6c-11 to account for the aggregate burden increase that will result
from this increase in respondents to that rule. We are not updating the
rule 6c-11 PRA analysis in any other respect.
---------------------------------------------------------------------------

    \1035\ See supra footnotes 613-616 and accompanying text.
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    Rule 6c-11 requires an ETF to disclose certain information on its
publicly-available website, to maintain certain records, and to adopt
and implement certain written policies and procedures. The purpose of
these collections of information is to provide useful information to
investors who purchase and sell ETF shares in secondary markets and to
allow the Commission to better monitor reliance on rule 6c-11 and will
assist the Commission with its accounting, auditing and oversight
functions. Information provided to the Commission in connection with
staff

examinations or investigations will be kept confidential subject to the
provisions of applicable law.
    The respondents to rule 6c-11 will be ETFs registered as open-end
management investment companies other than share class ETFs and non-
transparent ETFs. This collection will not be mandatory, but will be
necessary for those ETFs seeking to operate without individual
exemptive orders, including all ETFs whose existing exemptive orders
will be rescinded.
    Under the currently approved PRA estimates, 1,735 ETFs would be
subject to these requirements. The current PRA estimates for rule 6c-11
include 74,466.2 total internal burden hours, $24,771,740.10 in
internal time costs, and $1,735,000 in external time costs.
    In the Proposing Release, we estimated that the proposed amendments
to rule 6c-11 would result in an additional 164 leveraged/inverse ETFs
relying on that rule, resulting in an increase in the number of
respondents to 1,899 ETFs. This updated number of respondents resulted
in a total of 81,505.08 burden hours, $27,113,276.34 in internal time
costs, and $1,899,000 in external costs.
    We did not receive public comment relating to the PRA estimates for
rule 6c-11 in the Proposing Release. We continue to believe that the
current annual burden and cost estimates for rule 6c-11 are
appropriate, but that the amendments to rule 6c-11 will result in an
increase in the number of respondents. Specifically, we estimate that
an additional 172 ETFs (all leveraged/inverse ETFs) will rely on rule
6c-11, resulting in an increase in the number of respondents to 1,907
ETFs. Table 9 below summarizes these revisions to the estimated annual
responses, burden hours, and burden-hour costs based on the amendments
to rule 6c-11.

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BILLING CODE 8011-01-C

D. Form N-PORT

    We are amending Form N-PORT to add new items to Part B
(``Information About the Fund''), as well as to make certain amendments
to the form's General Instructions. Form N-PORT, as amended, will
require funds that are limited derivatives users under final rule 18f-4
to provide information about their derivatives exposure, and
exceedances of their derivatives exposure over 10% of their net
assets.\1036\ It also will require funds that are subject to the limit
on fund leverage risk in rule 18f-4 to provide certain information
about the fund's VaR during the reporting period.\1037\ The final
amendments to Form N-PORT incorporate several modifications from the
proposal: (1) The proposed requirements would have required all funds,
not just limited derivatives users, to report derivatives exposure
information; (2) the proposed requirements did not include the
requirement for funds that are limited derivatives users to report
exceedances of their derivatives exposure over the 10% threshold; and
(3) the final VaR reporting requirements decrease the number of
reported items that the proposal would have required and make certain
VaR-related information non-public. We estimate that 5,133 funds in the
aggregate, consisting of 2,437 limited derivatives users and 2,696
funds that are subject to the VaR-based limit on fund leverage risk,
will be subject to aspects of the Form N-PORT reporting requirements in
the final rule.
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    \1036\ See Item B.9 of Form N-PORT; supra section II.G.1.a.
    \1037\ See Item B.10 of Form N-PORT; see supra section II.G.1.b.
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    Preparing reports on Form N-PORT is mandatory for all management
investment companies (other than money market funds and small business
investment companies) and UITs that operate as ETFs and is a collection
of information under the PRA. Responses to the reporting requirements
will be kept confidential, subject to the provisions of applicable law,
for reports filed with respect to the first two months of each quarter.
The information that funds will report regarding limited derivatives
users' derivatives exposure and exceedances of the 10% derivatives
exposure threshold, information about a fund's median daily VaR and
median VaR Ratio, as applicable, and VaR backtesting exceptions will
not be made publicly available. All other responses to the new Form N-
PORT reporting requirements for the third month of the quarter will not
be kept confidential, but made public sixty days after the quarter end.
Form N-PORT is designed to assist the Commission in its regulatory,
disclosure review, inspection, and policymaking roles, and to help
investors and other market participants better assess different fund
products.\1038\
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    \1038\ The specific purposes for each of the new reporting items
are discussed in section II.G.1 supra.
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    Based on current PRA estimates, we estimate that funds prepare and
file their reports on Form N-PORT either by (1) licensing a software
solution and preparing and filing the reports in house, or (2)
retaining a service provider to provide data aggregation, validation
and/or filing services as part of the preparation and filing of reports
on behalf of the fund. We estimate that 35% of funds subject to the N-
PORT filing requirements will license a software solution and file
reports on Form N-PORT in house, and the remainder will retain a
service provider to file reports on behalf of the fund.
    Table 10 below summarizes our initial and ongoing annual burden
estimates associated with the amendments to Form N-PORT. One commenter
broadly opposed any new Form N-PORT reporting requirements on the
grounds that they generally increase burdens on funds, but did not
comment on PRA related burdens specifically.\1039\ Otherwise, the
Commission did not receive comments specifically addressing the
estimated burdens associated with the proposed Form N-PORT reporting
requirements. We have adjusted the proposal's estimated annual burden
hours and total time costs, on account of the modifications to the
proposed Form N-PORT requirements that we are adopting.
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    \1039\ ISDA Comment Letter.

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BILLING CODE 8011-01-P
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[GRAPHIC] [TIFF OMITTED] TR21DE20.013

BILLING CODE 8011-01-C

E. Form N-RN and Rule 30b1-10

    We are amending Form N-LIQUID (which we are re-titling as ``Form N-
RN'') to add new reporting requirements for funds subject to the VaR-
based limit on fund leverage risk pursuant to rule 18f-4 as well as
conforming amendments to rule 30b1-10.\1040\ We are adopting these
requirements substantially as proposed, with conforming amendments to
reflect changes to the proposed VaR requirements in the final rule.
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    \1040\ See Parts E, F, and G of Form N-RN; see also supra
section II.G.2 (noting that, in addition to registered open-end
funds, the scope of funds that will be subject to the requirements
of Form N-RN will expand to include registered closed-end funds and
BDCs).

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    A fund that determines that it is out of compliance with the VaR
test and has not come back into compliance within five business days
after such determination will have to file a non-public report on Form
N-RN providing certain information regarding its VaR test
breaches.\1041\ In addition, a fund that has come back into compliance
with either the relative VaR test or the absolute VaR test, as
applicable, must file a report on Form N-RN within one business day to
indicate that. We estimate that 2,696 funds per year will be required
to comply with either of the VaR tests, and the Commission will receive
approximately 54 filing(s) in aggregate per year in response to the new
VaR-related items that we proposed to include on Form N-RN, as
amended.\1042\
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    \1041\ See supra footnote 688. For purposes of this PRA
analysis, the burden associated with the amendments to rule 30b1-10
and rule 18f-4(c)(7) is included in the collection of information
requirements for Form N-RN.
    \1042\ The estimate at proposal was 30 filings in aggregate per
year. See Proposing Release, supra footnote 1, at n.682 and
accompanying text. However, in a modification from the calculation
at proposal, the final PRA analysis increases this total by
approximately 75% to 54 filings in aggregate per year.
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    Pursuant to the amendments to Form N-RN, preparing a report on this
form will be mandatory for any fund that is out of compliance with its
applicable VaR test for more than five business days, and for any fund
that has come back into compliance with its applicable VaR test. A
report on Form N-RN is a collection of information under the PRA. The
VaR test breach information provided on Form N-RN, as well as the
information a fund provides when it has come back into compliance, will
enable the Commission to receive information on events that could
impact funds' leverage-related risk more uniformly and efficiently and
will enhance the Commission's oversight of funds when significant fund
and/or market events occur. The Commission will be able to use the
newly required information that funds will provide on Form N-RN in its
regulatory, disclosure review, inspection, and policymaking roles.
Responses to the reporting requirements and this collection of
information will be kept confidential, subject to provisions of
applicable law.
    Table 11 below summarizes our initial and ongoing annual burden
estimates associated with preparing current reports in connection with
the amendments we are adopting to funds' current reporting
requirements. Staff estimates there will be no external costs
associated with this collection of information. We further assume
similar hourly and cost burdens, as well as similar response rates, for
responses to either a breach of the absolute VaR test or the relative
VaR test. Our assumptions furthermore take into account that the
information that funds must report on Form N-RN regarding a VaR test
breach includes data that will be available to funds in connection with
their compliance with rule 18f-4, and therefore funds will not need to
obtain or compile this information anew when they prepare reports on
Form N-RN. Several commenters expressed that the proposed rule would
result in more breaches of the VaR limits than estimated by the
Commission at proposal.\1043\ Although the final rule provides
incremental higher VaR limits than proposed, we have increased the
number of funds that we expect to be subject to the VaR-related items
on Form N-RN to reflect the potential that there could be more VaR
limit breaches than we had initially estimated. We have also adjusted
the proposal's estimated annual burden hours and total time costs to
reflect the Commission's updated views on typical time burdens
associated with similar reporting requirements.
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    \1043\ See supra sections II.D.2 and II.D.3 (discussing requests
from commenters to raise both the relative VaR and absolute VaR
limits in the proposal).
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BILLING CODE 8011-01-P

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F. Form N-CEN

    Form N-CEN is a structured form that requires registered funds to
provide census-type information to the Commission on an annual basis.
We are amending Form N-CEN to require a fund to identify whether it
relied on rule 18f-4 during the reporting period and whether the fund
has relied on certain provisions of the rule, substantially as
proposed.\1044\ In a modification from the proposal, we also are
amending Form N-CEN to require a fund to identify whether it has
invested in securities on a when-issued or forward-settling basis, or
with a non-standard settlement cycle, in reliance on the final rule.
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    \1044\ See supra section II.G.3.

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    Preparing a report on Form N-CEN, as amended, will be mandatory for
all registered funds, including money market funds. Responses will not
be kept confidential. We estimate that 5,524 funds will be subject to
the amendments to the Form N-CEN reporting requirements.\1045\
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    \1045\ We estimate that the number of funds that will be subject
to the amendments to the Form N-CEN reporting requirements includes
the number of funds that we estimate will be required to comply with
the derivatives risk management program requirement (2,766 funds),
plus the number of funds that we estimate will qualify as limited
derivatives users (2,437 funds), plus the number of money market
funds (420 funds), minus BDCs, which are not required to report on
Form N-CEN (99 BDCs). 2,766 + 2,437 + 420-99 = 5,524.
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    The purpose of Form N-CEN is to satisfy the filing and disclosure
requirements of section 30 of the Investment Company Act, and of
amended rule 30a-1 thereunder. The information required to be filed
with the Commission assures the public availability of the information
and is designed to facilitate the Commission's oversight of registered
funds and its ability to monitor trends and risks.
    Table 12 below summarizes our initial and ongoing annual burden
estimates associated with the amendments to Form N-CEN based on current
Form N-CEN practices and burdens associated with minor amendments to
the form. Staff estimates there will be no external costs associated
with this collection of information. One commenter broadly opposed any
new Form N-CEN reporting requirements on the grounds that they
generally increase burdens on funds, but did not comment on PRA related
burdens specifically.\1046\ We have adjusted the proposal's estimated
annual burden hours and total time costs, on account of the additions
to the proposed Form N-CEN requirements that we are adopting and the
Commission's updated views on typical time burdens associated with
similar reporting requirements.
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    \1046\ ISDA Comment Letter.

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BILLING CODE 8011-01-C

V. Final Regulatory Flexibility Analysis

    The Commission has prepared the following Final Regulatory
Flexibility Analysis (``FRFA'') in accordance with section 604 of the
Regulatory Flexibility Act (``RFA'').\1047\ It relates to new rule 18f-
4 and the final amendments to Forms N-PORT, N-LIQUID (re-titled ``Form
N-RN''), and N-CEN.\1048\ An

Initial Regulatory Flexibility Analysis (``IRFA'') was prepared in
accordance with the RFA and included in the Proposing Release.\1049\
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    \1047\ 5 U.S.C. 604.
    \1048\ As discussed above, we do not believe the conforming
amendments to Form N-2 (clarifying that funds do not have to
disclose in their senior securities table the derivatives
transactions and unfunded commitment agreements entered into in
reliance on rule 18f-4) or rule 22e-4 and Form N-PORT (removing
references to assets ``segregated to cover'' rendered obsolete by
rule 18f-4) result in any new reporting, recordkeeping, or
compliance burdens. See supra footnote 1007.
    Similarly, we do not believe the conforming amendment to rule
30b1-10 (adding registered closed-end funds to the scope of this
rule, reflecting the requirement in final rule 18f-4 for all funds
that experience certain VaR breach events to report information
about these events confidentially to the Commission on Form N-RN)
result in any new reporting, recordkeeping, or compliance burdens.
See supra footnote 1007.
    \1049\ See Proposing Release supra footnote 1, at section VI.
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A. Need for and Objectives of the Rule and Form Amendments