Search results for: "derivatives exposure"

This post continues our examination of how a fund must treat hedges when calculating its derivatives exposure to qualify as a limited derivatives user. Commenters on proposed Rule 18f-4 suggested several types of derivatives hedges, in addition to currency derivatives, that the Commission might exclude from derivatives exposure. In the release adopting Rule 18f-4 (the “Adopting Release”), the Commission agreed to exclude interest rate derivatives from the calculation of derivatives exposure, but rejected the other suggestions. These other hedging strategies should therefore be included in a fund’s derivatives exposure.

We previously discussed covered call options and purchased option spreads, which are derivatives transactions and should be included in derivatives exposure. Other potential hedges that should be included in derivatives exposure include the following. Continue Reading Rule 18f-4: Trimming Hedges—Hedges Included in Derivatives Exposure

Our post on the derivatives exposure equation began with a separate equation concerning interest rate and currency hedges. This post explains the significance of this equation and what hedges should be excluded from a fund’s derivatives exposure. Our next post will address hedges included in derivatives exposures before we raise some interpretive questions about how the exclusion should be applied. Continue Reading Rule 18f-4: Trimming Hedges—Hedges Excluded from Derivatives Exposure

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”

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

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

This post will bring to a close, for now, our survey of the requirements of new Rule 18f-4, which investment companies must comply with by August 19, 2022. This post considers whether a Chief Compliance or Risk Officer should seek to treat some or all of their funds as Limited Derivatives Users and how that choice, in turn, relates to the decision about whether to treat reverse repurchase agreements as derivatives transactions. But first, we review the compliance procedures required by Rule 18f-4 for (nearly) every fund. We also provide links to compliance checklists provided in earlier posts. Continue Reading Rule 18f-4 Wrap-Up

As with Fund-of-Funds, the release adopting Rule 18f-4 (the “Adopting Release”) devotes a section to sub-advised funds. We again consider three types of funds:

  • VaR Funds in which a sub-adviser manages their entire portfolio (“Single Sub-Adviser Funds”);
  • VaR Funds in which one or more sub-advisers manage a portion or “sleeve” of their portfolio (“Sleeve Funds”); and
  • Sub-advised funds that seek to qualify as Limited Derivatives Users.

The Adopting Release discusses the first two circumstances but is silent on the third. Continue Reading Compliance with Rule 18f-4 by a Sub-Advised Fund