Understanding Closed-End Funds

CEF

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 capital structure 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.


Next: Leverage from Portfolio Investments

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