Rule 18f-4: The 10% Buffer and Changes in Hedged Investments

By Stephen A. Keen and Andrew P. Cross

This post continues our examination of the “10% buffer” for Hedging Derivatives, which refers to the amount by which the notional amounts of Hedging Derivatives can exceed the value of hedged equity investments, par amount of hedged fixed-income investments or principal amount of hedged borrowings. In this post we examine what it means for Hedging Derivatives to exceed the 10% buffer.

Application of the 10% Buffer

The 10% buffer is intended to address:

situations, such as shareholder redemptions or fluctuations in the market value of a hedged investment, that can temporarily cause the notional amounts of the hedges to exceed the value of the hedged investments by more than a negligible amount.”

This should

avoid funds frequently trading (and incurring the attendant costs) to resize their hedges in response to small changes in value of the hedged investments.”

Consider, for example, a Limited Derivatives User holding euro denominated equity investments with a current value of €10 million that enters into 80 of the September 2022 Euro FX Futures to sell a total of €10 million for a total of $11,908,000. What would the consequences under Rule 18f-4 be if, a month later, the value of the equity investments has fallen to €9 million?

Continue to the full post at Asset Management ADVocate