On January 18, 2018, the Director of the Division of Investment Management, Dalia Blass, issued a Staff Letter to the Investment Company Institute (ICI) and the Securities Industry and Financial Markets Association (SIFMA) regarding the use of cryptocurrency mutual funds and ETFs. The letter requests comments from both the ICI and SIFMA, as well as the overall industry, on how the industry intends to comply with the Investment Company Act of 1940 (IC Act) requirements.
There are many compliance challenges for sponsors of mutual funds and ETFs that wish to focus on the trading of either cryptocurrency instruments directly or indirectly via futures contracts or derivatives. Cryptocurrency trading is a new market phenomenon that has taken off recently even though there are still many unanswered questions surrounding it. By issuing the Staff Letter, the SEC would like to hear the industry’s viewpoint in answering these questions.
Specifically, the SEC is looking to find out how the industry will address four major questions that raise concerns:
- Valuation – How will instruments be valued or “fair valued” in a standardized way so that funds can readily cut meaningful NAVs?
- Liquidity – Funds must be redeemable and have enough liquidity to meet redemptions. If these assets are deemed illiquid how will funds comply with new Rule 22e-4?
- Custody – How will funds custody these assets if they are physically held? There are currently no fund custodians that hold cryptocurrency assets.
- Arbitrage (ETFs) – How will “creation unit” purchases and redemptions be determined in such a fragmented market with extreme volatility and trading volumes?
Of course, fraud and market manipulation are also major concerns for regulators and the sale of cryptocurrency assets to retail investors is a known issue for Chairman Clayton. (See Statement on Cryptocurrencies and Initial Coin Offerings, SEC Chairman Jay Clayton, Dec. 11, 2017) The Commission suggests in the Staff Letter that it will not allow the use of Rule 485(a) post-effective amendments for any currently registered funds that are substantially invested in cryptocurrency assets. Notably, it also states that the Commission will not allow for the registration of any new funds with primary cryptocurrency strategies until the questions above are answered to its satisfaction.