This post is the second installment of our discussion of the compliance requirements of new Rule 18f-4.

The comments on proposed Rule 18f-4 revealed a significant lacuna in the rule resulting from two unrelated changes to current regulations. First, the SEC will rescind Investment Company Act Release No. 10666 (“Release 10666”) as of August 19, 2022, the same day funds must comply with Rule 18f-4. Second, money market funds are excluded from the exemptions for derivatives transactions provided by Rule 18f-4. This post will explain why this was a problem and how the final rule addresses it.
Continue Reading Exclusion of Non-Standard Settlements—Something for Every Fund in Rule 18f-4

This post continues our consideration of a carveout from the proposed Value at Risk (“VaR”) limitations of Rule 18f-4 for unfunded commitment agreements “because they do not present an opportunity for the fund to realize gains or losses between the date of the fund’s commitment and its subsequent investment ….” Our last post dealt with commitments to invest in a company’s equity. But the definition of “unfunded commitment agreement” would also include a contract “to make a loan to a company.” Commenters on the original Rule 18f-4 proposal contrasted these loan commitments with:

firm and standby commitment agreements, under which a fund commits itself to purchase a security with a stated price and fixed yield without condition or upon the counterparty’s demand.”

We do not believe the contrast is as stark as these commenters suggest. If our view is correct, we will need to search for additional factors to distinguish these loan commitments from commitment agreements that should be treated as derivatives transactions.
Continue Reading Re-Proposed Rule 18f-4: Unfunded Loan Commitments

Having completed our detour into regulations and interpretations other than re-proposed Rule 18f-4, this post returns to considering possible justifications for carving out “unfunded commitment agreements” from the proposed Value at Risk limitations of Rule 18f-4. We have previously explained why the first two justification identified in the proposing release are ill-founded, which leaves only the following argument for a carveout:

Commenters also asserted that unfunded commitment agreements do not give rise to the risks that Release 10666 identified and do not have a leveraging effect on the fund’s portfolio because they do not present an opportunity for the fund to realize gains or losses between the date of the fund’s commitment and its subsequent investment when the other party to the agreement calls the commitment.”

We believe this is true of some, but not all, commitments. To explain why, we begin with the most important element of the proposed definition of “unfunded commitment agreement:” that it is a commitment to the company receiving the loan or other investment.
Continue Reading Re-Proposed Rule 18f-4: Why Some Commitment Agreements may not have “Leveraging Effects”

Not content with Steve’s detour into the relationship between Rule 2a-7 and re-proposed Rule 18f-4, we would also like to point out a set of rules under which the Securities and Exchange Commission (“SEC”) and the Commodity Futures Trading Commission (“CFTC”) have wrestled with the distinctions between “swaps, security-based swaps and security-based swap agreements” and non-derivative transactions. Release No. 33-9938 (the “Release”) not only adopted regulations distinguishing swaps from other types of derivatives instruments (such as securities forwards) and securities, but also included interpretive guidance for distinguishing swaps from consumer and commercial agreements, contracts, and transactions. Several of the commercial transactions discussed in this Release correspond to the type of loan commitments the SEC proposes to include in the definition of “unfunded commitment agreement” in Rule 18f‑4. We suggest that some factors used to distinguish one type of derivative instrument (a swap) from commercial lending transactions may also help distinguish these transactions from derivatives instruments more generally.

Continue Reading Re-Proposed Rule 18f-4: Not Reinventing the Derivatives Wheel

My previous post tried to explain how Rule 2a-7 limits the “leveraging effects” of “firm commitments” made by money market funds. This post will add some important qualifications, compare the approach taken by Rule 2a-7 to the proposed approach in Rule 18f-4 and discuss the need to reconcile these rules.
Continue Reading What Rule 2a-7 Tells Us about Re-Proposed Rule 18f-4

This post continues my consideration of why certain “unfunded commitment agreements” should be carved out of the valuation at risk limitations of re-proposed Rule 18f-4. My previous post explained why two of the justifications offered for this carve out do not bear scrutiny. My current view is that the scope of the carve out depends on the third proposed justification: that some commitments may not have “leveraging effects.” This requires an understanding of the leveraging effects regulated by Section 18 of the Investment Company Act.

I will use the example of money market funds to explore “leveraging effects” because (a) it allows me to answer a question raised in the proposing release and (b) it illustrates another means of limiting leverage.
Continue Reading Money Market Funds and Re-Proposed Rule 18f-4

This post continues my assessment of the proposed treatment of unfunded commitments under re-proposed Rule 18f-4. My previous post questioned whether the proposed definition of an “unfunded commitment agreement” successfully carved these transactions out of the definition of “derivatives transactions.” This post begins my evaluation of why such a carve out may be warranted.

The SEC’s release cites three factors offered by commenters that the SEC agreed “distinguish unfunded commitment agreements from … derivatives transactions.” Unfortunately, the first two of these factors do not provide a sound basis for drawing such a distinction.
Continue Reading Re-Proposed Rule 18f-4: How Not to Distinguish Commitments from Derivatives

My initial posts on re-proposed Rule 18f-4 reflect my generally favorable reactions to the SEC’s attempt to develop a practical, hence imperfect, means of implementing the limitations on senior securities required by Section 18 of the Investment Company Act of 1940. My initial series of post written at the time Rule 18f-4 was first proposed attempted to explain some of the inherent difficulties of this task.

I will now turn to a more problematic matter: the proposed treatment of so-called “unfunded commitment agreements.” While I basically agree with the proposed approach of limiting commitments by requiring a reasonable means of meeting the fund’s obligations, I have reservations about how and why the rule proposes to implement this approach.
Continue Reading Does Re-Proposed Rule 18f-4 Have Commitment Issues?

On April 7, 2020, the Securities and Exchange Commission (the “SEC”) announced an update to the EDGAR system that would allow negative values to be entered in Item C.17 of Form N-MFP. Money market funds use Form N-MFP to report information to the SEC as of the end of each month. Item C.17 requires, for each security held by the fund, “[t]he yield of the security as of the reporting date.” The change was prompted by the recent downturn in rates for one-month and three-months Treasury bills, which may also have prompted some Treasury money market funds to restrict new investments.
Continue Reading A Negative Sign of the Times: Form N-MFP Can Report Negative Yields