3: Regulatory Leverage
Regulatory leverage is leverage as defined by the Investment Company Act of 1940, Regulatory leverage is always considered to be structural – ie, an intentional part of a fund’s design and capital structure.
Regulatory leverage includes borrowings or debt issued by the fund, as well as various types of preferred shares (equity). Both of these change a fund’s
by introducing additional capital that is senior to a fund’s common shares. This seniority means that all interest payments for debt and all declared preferred share dividends must be paid before any common share dividends are paid. If a fund is liquidated, the proceeds pay borrowings/debt principal first, then preferred shareholders, with the remainder going to common shareholders.
Unless a fund’s prospectus describes stricter leverage limits, the ’40 Act limits regulatory leverage:
Is a strategic part of a fund's overall structure
Creates a systematic level of additional investment exposure
Types of regulatory leverage include (but are not limited to):
Debt: Borrowings or debt issued by a fund
Regulations for debt leverage require that the value of assets (capital) raised by borrowing must be backed (covered) by the total value of portfolio assets at least 3 to 1. In other words, the fund’s maximum debt leverage is 33%.
Equity (Preferred Shares)
Regulations for equity leverage require that preferred share assets be backed by total portfolio assets at least 2 to 1, meaning maximum equity leverage is 50%.
Variable-rate demand preferred shares (VRDP)
MuniFund Term Preferred (MTP)
Variable MuniFund Term Preferred (VMTP)
Click on each type for more details.
Leverage from Portfolio Investments