In a statement issued on May 11, 2021 (the “Statement”), the staff of the U.S. Securities and Exchange Commission’s (the “SEC”) Division of Investment Management (the “staff”) addressed concerns arising under the Investment Company Act of 1940, as amended (the “1940 Act”) and the rules thereunder with fund investments in the Bitcoin futures market. The staff noted its understanding that certain open-end funds (“mutual funds”) registered under the 1940 Act are investing or are seeking to invest in cash-settled Bitcoin futures that are traded on the Chicago Mercantile Exchange, which is regulated by the U.S. Commodity Futures Trading Commission (“Bitcoin futures”). The staff conveyed its limited view that mutual funds, and in certain cases closed-end funds registered under the 1940 Act (“CEFs”), may invest in Bitcoin futures, provided that such mutual funds and CEFs disclose appropriate strategies for, and all material risks inherent in, an investment in Bitcoin futures.1 The staff encouraged CEFs, exchange-traded funds (“ETFs”) and other types of 1940 Act-regulated funds that intend to invest in Bitcoin futures to consult with the staff (prior to filing a registration statement) on how such funds intend on ensuring compliance with the 1940 Act, the rules thereunder and the federal securities laws.
The staff announced that, in coordination with the staff from the SEC’s Division of Examinations, it will closely monitor and assess such mutual funds’ and their investment advisers’ ongoing compliance with the 1940 Act, the rules thereunder and the federal securities laws.
Evolution of Issues Highlighted in 2018 Cryptocurrency Holdings Letter
The Statement was issued more than three years after the staff issued a letter on prospective fund investments in cryptocurrency-related holdings (the “Cryptocurrency Holdings Letter”)2. The Cryptocurrency Holdings Letter raised questions in the following substantive areas with respect to registered funds’ investments in cryptocurrencies and cryptocurrency-related assets: valuation, liquidity, custody, arbitrage mechanisms for ETFs and potential manipulation and other risks. Among other things, the Cryptocurrency Holdings Letter expressed the staff’s concerns that a fund that invests in cryptocurrency-related assets should address:
- the proper mechanisms to determine the fair value of cryptocurrency-related investments and the daily net asset value for the fund;
- sufficient liquidity to satisfy daily redemption requests; and
- the ability to satisfy the custody-related rules under the 1940 Act.
The staff acknowledged in the Statement that the Bitcoin futures market has sufficiently developed since its issuance of the Cryptocurrency Holdings Letter (e.g., the Bitcoin futures market now has increased trading volumes and open-interest positions and consistently produces reportable prices for Bitcoin futures) to support trading by certain mutual funds and CEFs. The staff also noted that the Bitcoin futures market has not presented the custody-related issues identified in the Cryptocurrency Holdings Letter because Bitcoin futures are cash-settled.
Staff Will Continue to Monitor
As part of its ongoing monitoring of mutual funds’ investments in Bitcoin futures, the staff, in coordination with staff from the Division of Economic and Risk Analysis and Division of Examinations, expects to:
- analyze the liquidity and depth of the Bitcoin futures market;
- analyze mutual funds’ ability to liquidate Bitcoin futures and the efficacy of mutual funds’ derivatives risk management;
- monitor funds’ valuations of holdings in the Bitcoin futures market;
- consider the impact of mutual fund participation in the Bitcoin futures market on valuations in that market, and the impact on valuation of any disruptions in the underlying Bitcoin markets;
- consider mutual funds’ liquidity classification of any position in the Bitcoin futures market and the basis for such classification;
- assess the ongoing impact of the potential for fraud or manipulation in the underlying Bitcoin markets and its possible influence on the Bitcoin futures market; and
- consider whether, in light of the experience of mutual funds investing in the Bitcoin futures market, the Bitcoin futures market could accommodate ETFs.
S&K Observations
This first public statement by the staff regarding Bitcoin and the Bitcoin futures market under Chairman Gensler shows the evolution of the staff’s positions on investments in Bitcoin futures by registered investment companies. The staff’s statement regarding ETFs and CEFs suggests that it believes a cautious approach towards the use of Bitcoin futures as a principal strategy is warranted, at least until the market develops further. S&K will continue to monitor and report on these developments and the staff’s future efforts towards greater transparency in its approach to cryptocurrency-related investments by 1940 Act-regulated funds.
