We promised a few posts back to discuss how a Limited Derivatives User should apply what we termed the “10% buffer” to determine whether currency and interest-rate derivatives may be excluded from its derivatives exposure. This post begins to tackle the question What is the 10% Buffer? and explain how it might work.

Continue Reading Rule 18f-4: The 10% Buffer and Adjusting Notional Amounts of Hedges

Yesterday, the Investment Adviser Association published our article on “Dealing with the New Derivatives Rule: A Guide of Legal and Compliance Professionals” in the “Compliance Corner” of its September 2021 IAA Newsletter.

At a high level, the article:

  • Provides a background on the limitations on senior securities under the Investment Company Act of

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 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