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

Our last post explained the two basic alternatives for managing derivatives risks under new Rule 18f-4 by qualifying either as a Limited Derivatives User or a VaR Fund. This post outlines 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.
Continue Reading VaR Funds vs. Limited Derivatives Users—Programs vs. Procedures

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”).


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