Jack Inglis

“[The] vague and overbroad rule exceeds US SEC’s statutory authority, is arbitrary and capricious, and has severe consequences for financial markets,” said the National Association of Private Fund Managers (NAPFM), Managed Funds Association (MFA), and Alternative Investment Management Association (AIMA), jointly.

The two adopted rules require certain hedge funds, among other market participants, to register if they meet one of two qualitative standards, with the final rule set to inflict more scrutiny and compliance burdens on market players.

NAPFM, MFA, and AIMA are aiming to have the rule be vacated in its entirety due to three key reasons: that the SEC lacks the statutory authority to adopt the new definition; that the decision-making is “arbitrary and capricious”; that the rule is “contrary to law” due to its imposing a burden on competition which is outside the scope of the SEC’s purposes.

NAPFM asserted that the redefinition could ultimately lead to a decrease in liquidity: “The US SEC’s redefinition of ‘dealer’ upsets a century’s worth of understanding about the meaning of that term under the Exchange Act […] the agency here tries to extend its reach over private funds in ways Congress never imagined. The Dealer Rule – purportedly designed to increase liquidity in trading markets – could ultimately have the effect of decreasing such liquidity.”

Under the final rules, an entity would qualify as a dealer or government securities dealer if they regularly express trading interest as close to the best price on both sides of the market for the same security, or earn revenue primarily from capturing bid-ask spreads or from capturing incentives offered by trading venues.

If applicable, the new rule requires the market participants in question to register with the commission, become members of a self-regulatory organisation (SRO), and comply with federal securities laws and regulatory obligations.

Jack Inglis, AIMA CEO, said: “The US SEC has exceeded its statutory authority by incorrectly concluding that customers of dealers may be dealers themselves – a clear departure from the statutory definition and understanding of what has meant to be a securities ‘dealer’ for the past 90 years.

“This rule will force certain hedge funds – who are not dealers and have never been considered dealers – to either register as dealers, thereby subjecting them to an unworkable regulatory framework, or force them to significantly curtail or cease altogether their trading activity.” 

He added that both of these results are set to result in unnecessary and significant harm to markets, investors, and certain funds.

The SEC has also confirmed that the final rules exclude: any person that has (or controls) assets that total less than $50 million, investment companies registered under the Investment Company Act of 1940, central banks, sovereign entities, and international financial institutions (as defined in the final rules).

Read more: SEC tags hedge funds trading Treasuries as ‘dealers’ under new rule change

Bryan Corbett, president and chief executive of MFA, added: “We were left with no choice but to challenge the Dealer Rule, because it will harm markets and create tremendous uncertainty for investors.

“[…] Alternative asset managers are not dealers. They are customers of dealers. If the rule is permitted to stand, it could mean that managers in scope and the funds they manage would lose their customer protections with their dealer counterparties and could not participate in IPOs. This would harm funds, their investors, and issuers looking to raise capital.”

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Regulatory authorities in Austria, Belgium, France, Greece and Spain have all confirmed that the restrictions on short selling, which were implemented throughout last month as markets became increasingly volatile, will be extended until 18 May, with the possibility for further renewal.

The European Securities and Markets Authority (ESMA) welcomed the extension in a statement, adding that the measures can be lifted before the deadline if risks of a loss of market confidence are reduced.

“ESMA considers that the proposed measures are justified by current adverse events or developments which constitute a serious threat to market confidence and financial stability, and that they are appropriate and proportionate to address the existing threat to market confidence in those five markets,” the EU markets regulator said.

A blog post published prior to the extension from Bryan Corbett, the chief executive and president of the Managed Funds Association (MFA), which represents hedge funds, argued that authorities should let the ban expire.

“The initial results from bans imposed in recent weeks already point to problems: Bid-ask spreads for affected shares widened more than 15 percent compared to unrestricted shares since the imposition of the bans,” Corbett wrote.

“That means the gap between the price at which someone will sell and the price at which another will buy grew because of the restrictions. This spread widening is effectively a tax on all investors trading the affected securities and diminishes liquidity at a time when markets need it most desperately.”

Similar warnings have been echoed by exchange group’s and central counterparties, with the World Federation of Exchanges (WFE) warning soon after the bans were implemented that the move would produce unintended results.

“Banning short-selling interferes with price formation, thereby increasing uncertainty. That can only artificially amplify volatility and probability of default, the opposite effect to that claimed, and hampers the ability of markets to serve the real economy. It is not – and never has been – true that bans have any other, positive effect on market activity or price levels,” said Nandini Sukumar CEO of WFE.

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