This post continues our discussion of the calculation of “gross notional amounts” included in a fund’s “derivatives exposure” under Rule 18f-4. Previously, we identified the best guidance we could find on how to calculate a derivatives transaction’s gross notional amount, and three adjustments to such amounts permitted by the rule’s definition of derivatives exposure. In this post, we discuss another adjustment not anticipated by Rule 18f‑4, but which we believe is necessary to avoid a fund that purports to be a limited derivatives user from circumventing the 10% limit on its derivatives exposure. Continue Reading Derivatives Exposure: Adjusting for Multipliers
Our previous post gave the best account we could of what the SEC staff has said about calculating the “gross notional amount” of derivatives transactions. In this post, we examine three adjustments that a fund may (but is not required to) make when calculating its “derivatives exposure.” Specifically, a fund may:
- exclude any closed-out positions;
- delta adjust the notional amounts of options contracts; and
- convert the notional amount of interest rate derivatives to 10-year bond equivalents.
We anticipate that a fund seeking to qualify as a “limited derivatives user” would make these adjustments to lower its derivatives exposure. Continue Reading Derivatives Exposure: Adjusting Notional Amounts
In this post, we tackle the question of how to calculate the “gross notional amount” of a derivatives transaction for purposes of the limited derivatives user provision of Rule 18f-4. This is a surprisingly difficult question because, although the adopting release for Rule 18f-4 (the “Adopting Release”) refers to “notional amount” 63 times, the release never directly addresses what the term means. We think we found an answer, but it required us to wind our way through a series of earlier SEC statements. Continue Reading Derivatives Exposure: A Circuitous Path to “Gross Notional Amounts”
The U.S. Securities and Exchange Commission granted effectiveness to the registration statement of a client of Perkins Coie, which is the first known registered investment company structured as a Maryland Benefit Corporation. As interest in socially responsible investing continues to grow, it is possible to utilize a governance model that commits an entity through state law organizational documents to pursue broader public benefits, beyond just the pecuniary interests of shareholders. Continue Reading Perkins Coie Shepherds the First Registered Investment Company Structured as a Maryland Benefit Corporation
Having provided two “big pictures” of the calculation of a fund’s “derivatives exposure,” we resume with an in-depth examination. We begin by considering how to determine the “gross notional amount” of a derivatives transaction. This post may contain our only categorical conclusion regarding derivatives exposure: gross notional amounts must be absolute values expressed in U.S. dollars. Continue Reading Derivatives Exposure under Rule 18f-4: Notional Apples and Oranges
On April 9, 2021, the SEC’s Division of Examinations (the “Division”) published its first risk alert detailing deficient and effective practices among investment advisers and registered and private funds (“Firms”) offering ESG strategies. The SEC is not alone in its focus on ESG matters as the CFTC and its Climate Risk Unit (“CRU”) continue to assess the risks to U.S. financial stability posed by climate change. Continue Reading The SEC’s ESG Risk Alert and the CFTC’s New Climate Risk Unit
Our last post provided a big picture summary of the steps required to calculate a Fund’s “derivatives exposure” for purposes of new Rule 18f-4. The post may have left an impression that this process should not be that difficult. To provide additional perspective, we offer the following equation for calculating derivatives exposure.
If interest rate and currency hedges satisfy the following condition:
Then a Fund will be a limited derivatives user when:
Our last post outlined the essential differences between VaR Funds and Limited Derivatives Users: primarily that the former must adopt a derivatives risk management program (a “DRM Program”) while the latter need only have policies and procedures. Our post observed that the less prescriptive regulatory requirements may make operating as a Limited Derivative User an attractive alternative for many management investment companies (including business development companies but excluding money market funds, a “Fund”). As promised at the end of that post, this post initiates our exploration of the challenges of qualifying as a Limited Derivatives User. We begin by providing a high-level step-by-step guide to calculating a Fund’s “derivatives exposure.” Continue Reading Derivatives Exposure: Why It Matters And How To Calculate It
Our last post explained the two basic alternatives for managing derivatives risks under new Rule 18f-4 by qualifying either as a Limited Derivatives User or a VaR Fund. This post outlines the essential differences between VaR Funds and Limited Derivatives Users, primarily that the former must adopt a derivatives risk management program (a “DRM Program”) while the latter need only have policies and procedures. Continue Reading VaR Funds vs. Limited Derivatives Users—Programs vs. Procedures
Rule 18f-4 is somewhat unusual in that it gives management investment companies (including business development companies but excluding money market funds, “Funds”) alternative means of complying with its exemption from Sections 18 and 61. A Fund may either:
- Limit the way and extent to which the Fund engages in derivatives transactions (a “Limited Derivatives User”), or
- Adopt a Derivatives Risk Management Program (a “DRM Program”) that, among other requirements, limits the Fund’s Value-at-Risk (“VaR”) relative to an index, its non-derivatives portfolio or its net assets (a “VaR Fund”).