WASHINGTON, DC – Managed Funds Association (MFA) today submitted a comment letter to the U.S. Securities and Exchange Commission (SEC) calling for the proposed custody rule to be withdrawn and only re-proposed after addressing fundamental flaws with the proposal and conducting a thorough cost-benefit analysis. MFA believes the current proposal is overly broad and could have negative implications across various financial markets.
MFA argues that the proposal has the potential to significantly disrupt crucial financial markets such as credit markets, prime brokerage, over-the-counter (OTC) derivatives, and commodities markets. The proposal could also substantially change the way transactions are conducted in these and other asset classes, in ways that the SEC has inadequately examined or overlooked entirely.
“Alternative asset managers recognize the importance of safeguarding client assets. The SEC’s one-size-fits-all approach with no regard to asset class, cost, benefit, or feasibility will have severe implications for investors, including pensions, foundations, and endowments,” said MFA President and CEO Bryan Corbett. “The proposal risks shutting down entire markets and requiring the renegotiation of all custody agreements for entire industries. We urge the SEC to withdraw the rule until they conduct a thorough cost-benefit analysis to ensure subsequent proposals effectively safeguard investors without jeopardizing market stability and integrity.”
MFA highlights that the proposal to extend safekeeping requirements to all asset classes lacks evidence of widespread weaknesses or risks in current custodial practices for traditional assets. The letter points out that the SEC is requiring custodial services that are currently unavailable or limited, yet is also demanding compliance within twelve months.
The letter calls on the SEC to withdraw the proposal. However, if the SEC intends to re-propose the rule, MFA’s comment letter offers numerous substantial adjustments that would help alleviate the undue burdens and excessive costs of the current proposal. More details about the comment letter are available below.
MFA writes that the SEC has failed to conduct an adequate cost-benefit analysis of the impact of the proposed custody requirements on certain asset classes. From the letter:
“Although the Commission devotes several paragraphs to discussing the potential costs associated with expanding the scope of assets subject to the rule to include crypto assets, the Commission does not address at all the potential costs associated with expanding the scope of assets to include regularly traded commodities, syndicated loans, derivative contracts, and securities financing agreements, among many other asset classes.”
MFA argues that the proposal, when applied to bilateral financial contracts and collateral in margin accounts, would not only be challenging to put into practice but also excessively cumbersome. From the letter:
“The requirement to maintain a bilateral financial contract with a qualified custodian that would ‘maintain possession or control’ over those contracts will be practically difficult, if not impossible, to implement, and it is not clear that a qualified custodian will introduce meaningful protection from an investor perspective.”
“The requirement to maintain collateral exchanged in connection with financial contracts and other transactions with a qualified custodian, and the attendant asset segregation requirements, will impose unnecessary and burdensome costs and does not account for the existing regulatory framework applicable to collateral usage, including in respect of broker-dealer margin accounts and by derivatives counterparties.”
MFA notes that the proposal fails to adequately consider the application of safekeeping requirements to loan agreements and syndicated loan markets. From the letter:
“Similar to the issues identified above with respect to OTC derivatives, the Proposal does not address the impracticalities of extending safekeeping requirements to loan agreements that are used in the syndicated loan market and other credit markets. […] This could effectively preclude advisory clients from participating in the syndicated loan market and other credit markets. As noted below, the syndicated loan market is an expansive and critical component of the U.S. financial markets more generally.”
MFA underlines that the proposal would fundamentally disrupt critical commodities markets. From the letter:
“Given the volume of trading in these markets, market participants subject to the proposed safeguarding rule may simply stop trading in these markets rather than incur the additional costs and burdens associated with transaction verification.”
“Other industries with “physical assets” outside of the Commission’s competence and authority include agriculture, chemicals, mining, timber, vintage and antique items and art. The proposed safeguarding rule could cause other market participants to pause, or even avoid, transacting in these commodities with investment advisers, thereby reducing market liquidity and harming the interests of investment adviser customers seeking returns derived from the commodities markets.”
MFA’s comment letter is available here.
About the Global Alternative Asset Management Industry
The global alternative asset management industry, including hedge funds, credit funds, and crossover funds, has assets under management of $4 trillion (Q4 2022). The industry serves thousands of public and private pension funds, charitable endowments, foundations, sovereign governments, and other global institutional investors by providing portfolio diversification and risk-adjusted returns to help meet their funding obligations and return targets.
About Managed Funds Association
Managed Funds Association (MFA), based in Washington, DC, New York, Brussels, and London, represents the global alternative asset management industry. MFA’s mission is to advance the ability of alternative asset managers to raise capital, invest, and generate returns for their beneficiaries. MFA advocates on behalf of its membership and convenes stakeholders to address global regulatory, operational, and business issues. MFA has more than 170 member firms, including traditional hedge funds, credit funds, and crossover funds, that collectively manage nearly $2.2 trillion across a diverse group of investment strategies. Member firms help pension plans, university endowments, charitable foundations, and other institutional investors to diversify their investments, manage risk, and generate attractive returns over time.