By Lisa Lambert
WASHINGTON (Reuters) - U.S. regulators are considering restrictions on how mutual, exchange-traded and other funds can use derivatives, with the Securities and Exchange Commission head saying she is concerned that investors are exposed to too much risk.
"Funds can experience substantial and rapid losses from investments in derivatives, and can be forced to sell investments under adverse conditions and take other measures to meet derivatives-related obligations, which can harm investors," SEC Chair Mary Jo White said on Friday at a commission meeting on the proposal.
The proposal, White said, would "modernize the regulation of funds' use of derivatives and safeguard both investors and our financial system."
Three out of four SEC commissioners voted to take the proposed rule to the next step on the path to approval, a 90-day public comment period. Commissioner Michael Piwowar, a Republican, voted against advancing it.
The proposed rule would require funds to segregate assets for covering mark-to-market liability and set aside an amount for future losses on derivatives. Funds would need to use cash and cash equivalents for covering derivatives transactions, White said.
A fund would have to comply with a portfolio limitation on either exposure to or risk from derivatives.
The fund could agree to top off the value of its exposure to 150 percent of its net assets, according to the SEC.
Alternatively, it could have exposure of up to 300 percent of net assets if it passes a test on whether its derivatives transactions reduce its market risk.
Piwowar said he could not support the proposal in its entirety and that other recently proposed or adopted rules addressed funds' uses of derivatives.
"Many of these rules will either have a direct impact on the risks of derivatives positions held by funds, or will provide us with data that could be used to better understand how we should regulate this market," Piwowar said.
But Commissioner Luis Aguilar, a Democrat, said the proposal was needed to increase transparency and understanding, as well as to protect retail investors.
Aguilar, who is stepping down from the commission, said derivatives regulation was still "a work in progress."
(Additional reporting by Trevor Hunnicutt in New York; Editing by Lisa Von Ahn)