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

This post continues our discussion of the calculation of “gross notional amounts” included in a fund’s “derivatives exposure” under Rule 18f-4. Previously, we identified the best guidance we could find on how to calculate a derivatives transaction’s gross notional amount, and three adjustments to such amounts permitted by the rule’s definition of derivatives exposure. In this post, we discuss another adjustment not anticipated by Rule 18f‑4, but which we believe is necessary to avoid a fund that purports to be a limited derivatives user from circumventing the 10% limit on its derivatives exposure.
Continue Reading Derivatives Exposure: Adjusting for Multipliers

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

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

This is the sixth installment of our discussion of the compliance requirements of new Rule 18f‑4 and wraps up our discussion of paragraph (d) of the new rule and its application to business development companies (“BDCs”), closed-end funds and open-end funds other than money market funds (collectively, “Funds”). This posts identifies which Funds need to update their asset coverage procedures for compliance with Section 18 of the Investment Company Act of 1940 and what those updates should entail.
Continue Reading Checklist for Including Reverse Repos and Similar Financing Transactions in Asset Coverage Procedures

This is the fifth installment of our discussion of the compliance requirements of new Rule 18f‑4 and completes our consideration of paragraph (d) of the new rule and its application to business development companies, closed-end funds and open-end funds other than money market funds (“Funds”). Our two previous posts considered the application of that paragraph to reverse repurchase agreements (“reverse repos”) and “similar financing transactions.” This posts identifies transactions that the adopting release (the “Release”) indicates would not be similar to reverse repos. These transactions fall into two categories: (a) derivatives instruments that will be subject to the conditions of paragraph (c) of Rule 18f‑4 and (b) transactions not at all subject to Rule 18f‑4.
Continue Reading Transactions Not Similar to Reverse Repos under Rule 18f-4(d)