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:

Where: Continue Reading The Derivatives Exposure Equation

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”).

Continue Reading What Kind of Derivatives User Is Your Fund?

Acting SEC Chair Allison Herren Lee continues to aggressively promote the SEC’s ESG agenda by launching a dedicated ESG webpage on the SEC’s website and speaking in support of ESG initiatives. The SEC’s Asset Management Advisory Committee (“AMAC”) is also moving forward with important ESG recommendations, including promotion of diversity and inclusion measures. Continue Reading The SEC Is All in on ESG, Including (Potentially) D&I Issues

Having completed our review of derivatives transactions, we now consider the risks such transactions may pose. Rule 18f-4(a) defines “derivatives risks” to include “leverage, market, counterparty, liquidity, operational, and legal risks and any other [material] risks.” The adopting release (the “Release”) provides helpful descriptions of these risks and some examples. Continue Reading What Risks May Be Associated with Derivatives Transactions

This post completes our exploration of the definition of “derivatives transactions” in Rule 18f-4, which is relevant to business development companies, closed-end funds and open-end funds other than a money market fund (“Funds”). Our object is to generate a fairly comprehensive list of what is, is not, and may be a “derivatives transaction” by using our touchstone of a “future payment obligation” in combination with the literal definition in the rule and points made in earlier posts. Continue Reading Rule 18f-4 Derivatives Transactions Recap

In this post, we continue our exploration of the definition of “derivatives transaction” in new Rule 18f-4, which is relevant to business development companies, closed-end funds and open-end funds other than a money market fund (“Funds”). Our last post discussed examples of derivatives that fall outside of the definition. This post considers transactions that may not pose the risks addressed by Rule 18f-4 but which are nevertheless subject to the rule. Subsequent posts will explain why this overbreadth is not as bad as it might seem. Continue Reading Transactions that Are “Derivatives Transactions” under Rule 18f-4

The pace of statements on ESG issues from SEC Commissioners on both sides of the political aisle shows no signs of abating. As Gary Gensler’s confirmation as SEC chair nears and acting Chair Allison Herren Lee continues to highlight the SEC’s prioritization of climate and other ESG matters affecting the financial markets, Commissioners Elad Roisman and Hester Pierce have voiced a need for restraint. Continue Reading Details on the SEC’s ESG Priorities, an Invitation to Comment, and Words of Caution