Our last two posts surveyed what Rule 18f-4 and its adopting release (the “Release”) tell us about excluding currency and interest-rate derivatives from the derivatives exposure of a fund seeking to comply with the Limited Derivatives User requirements of Rule 18f-4(c)(4). The Release indicates that the SEC intends to exclude only those derivatives that:

will predictably and mechanically provide the anticipated hedging exposure without giving rise to basis risks or other potentially complex risks that should be managed as part of a derivatives risk management program.”

This post considers questions we have encountered in applying this exacting standard to currency hedging strategies.