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Similarities and Differences between U.S. and German Regulation of the Use of Derivatives and Leverage by Mutual Funds – What Can Regulators Learn from Each Other?

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  • GaÅ‚kiewicz, Dominika

Abstract

This study analyzes current regulation with respect to the use of derivatives and leverage by mutual funds in the U.S. and Germany. After presenting a detailed overview of U.S. and German regulations, this study thoroughly compares the level of flexibility funds have in both countries. I find that funds in the U.S. and Germany face limits on direct leverage (amount of bank borrowing) of up to 33% and 10% of their net assets, respectively. Funds can extend these limits indirectly by using derivatives beyond their net assets (e.g., by selling credit default swaps protection with a notional amount equal to their net assets). Additionally, issuer-oriented rules in the U.S. and Germany account for issuer risk differently: U.S. funds have greater discretion to undervalue derivative exposure compared to German funds. All analyses of this study reveal that under existing derivative and leverage regulation, funds in both countries are able to increase risk by using derivatives up to the point at which it is possible for them to default solely due to investments in derivatives. The results of this study are highly relevant for the public and regulators.

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  • GaÅ‚kiewicz, Dominika, 2014. "Similarities and Differences between U.S. and German Regulation of the Use of Derivatives and Leverage by Mutual Funds – What Can Regulators Learn from Each Other?," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 474, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    • Handle: RePEc:trf:wpaper:474
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    References listed on IDEAS

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    1. Kempf, Alexander & Ruenzi, Stefan & Thiele, Tanja, 2009. "Employment risk, compensation incentives, and managerial risk taking: Evidence from the mutual fund industry," Journal of Financial Economics, Elsevier, vol. 92(1), pages 92-108, April.
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    More about this item

    Keywords

    Regulation; mutual funds; leverage; derivative; credit default swaps;
    All these keywords.

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation

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