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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”).

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Continue Reading What Kind of Derivatives User Is Your Fund?

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

In this, the twelfth installment of our review of the compliance requirements of new Rule 18f‑4, we leave the peripheral transactions addressed in the rule (i.e., delayed-delivery transactions, reverse repurchase agreements, and unfunded commitment agreements) and plunge into the core of the rule: “derivatives transactions” regulated by paragraph (c). To prepare for this, we need to understand some core concepts, including “derivatives transactions,” “derivatives risks” and “value-at-risk testing.”

We begin by seeking a bright line for separating investments not subject to Rule 18f-4 from those that may be. We find that whether a Fund has a future payment (or delivery) obligation is what matters the most when determining whether a particular transaction will be regulated as a derivatives transaction under Rule 18f-4.…
Continue Reading Derivatives that Are Not “Derivatives Transactions” under Rule 18f-4

This eleventh installment of our review of the compliance requirements of new Rule 18f‑4 as it applies to business development companies, closed-end funds and open-end funds other than money market funds (“Funds”) completes our discussion of unfunded commitment agreements. Here we consider what changes may be required for a Fund to comply with paragraph (e) of Rule 18f‑4. We suspect this may prove relatively easy for an open-end Fund.…
Continue Reading Compliance Checklist for Unfunded Commitment Agreements

This is the tenth installment of our review of the compliance requirements of new Rule 18f‑4 as it applies to business development companies, closed-end funds and open-end funds other than a money market fund (“Funds”). We have previously discussed the asset sufficiency risk posed by unfunded commitment agreements and the means by which paragraph (e) addresses this risk. This post will use these concepts to develop a working definition of when a firm or stand-by commitment should be treated as an unfunded commitment agreement.…
Continue Reading Identifying Unfunded Commitment Agreements

This is the ninth installment of our review of the compliance requirements of new Rule 18f‑4. Our last post explained why unfunded commitment agreements present asset sufficiency risk but did not create leverage risk. In this post, we will explain how paragraph (e) of the new rule controls asset sufficiency risk, tracing its origins back to Release No. IC-10666 (“Release 10666”).…
Continue Reading Unfunded Commitment Agreements under Rule 18f-4: The Last Vestige of Release 10666

The SEC’s Acting Chair, Commissioner Allison Herren Lee, was a vocal critic of the SEC’s approach to environmental, social and governance (“ESG”) matters under former Chair Jay Clayton. She voted against the SEC’s 2020 guidance and amendments to Regulation S-K because they did not go far enough in requiring disclosure from public companies about climate change and diversity metrics, noting that climate risk is a new type of systemic risk of “colossal and potentially irreversible risk of staggering complexity” and arguing that “it’s time to consider how to get investors the diversity information they need to allocate their capital wisely.”  “Consistent, reliable, and comparable disclosures of the risks and opportunities related to sustainability measures, particularly climate risk,” she said, is material information that investors need in their decision-making process.

The Statement on the Review of Climate-Related Disclosure from Commissioner Lee and the ESG Funds Investor Bulletin from the SEC’s Office of Investor Education and Advocacy released last week were thus not surprising. They were also likely only the first in a series of ESG-related actions to come from the SEC.…
Continue Reading ESG at the SEC: Hints of More to Come

Subject to Steve’s caveat regarding the definition of an “unfunded commitment agreement,” we continue our exploration of Rule 18f-4 with a focus on the treatment of such commitments under paragraph (e) of the new rule. Like paragraph (d), (e) applies only to business development companies, closed-end funds and open-end funds other than money market funds (“Funds”). We begin with a conceptual question: how can a contract to lend money and a contract to repay borrowed money both be “senior securities” under Section 18?…
Continue Reading Why Are Unfunded Commitment Agreements “Senior Securities?”