SEC Re-Proposes Investment Company Derivatives Rule under the Investment Company Act

Sullivan & Worcester

The U.S. Securities and Exchange Commission (the “SEC”) re-proposed on November 25, 2019 rules under the Investment Company Act of 1940 (the “1940 Act”) relating to, among other things, use by investment companies of derivatives and other types of instruments.[1] The SEC also proposed new rules applicable to brokers and investment advisers relating to sales practices in connection with the sale of shares of certain “leveraged/inverse investment vehicles.” As stated in the Proposing Release, those proposed rules are intended to enhance the SEC’s ability to effectively oversee the use of derivatives by investment companies, as well as to give the SEC and the public greater insight into the impact of the use of derivatives on investment company portfolios.


This is only a proposal. You are not required to take any action at this time.

This proposal applies to open- and closed-end investment companies, business development companies (BDCs), and certain ETFs, which use derivatives and engage in certain other types of transactions.

If adopted as proposed, the new rules would include

  • New responsibilities for fund boards
  • New fund compliance requirements
  • New fund reporting requirements
  • New due diligence requirements for brokers and investment advisers placing orders to purchase certain fund shares for retail investors

Treatment of Derivatives Currently under the 1940 Act and the Original (2015) Proposing Release

Current Regulations of Derivative Use

“Derivatives” generally may be defined as instruments and contracts that have a value that is based upon, or derived from, an asset or other metric. Derivatives may be either exchange-traded, such as futures contracts, or traded over-the-counter (OTC), such as forward contracts and swaps. Funds principally have used derivatives for hedging specific risks (e.g., foreign currency risk), higher returns, and/or as an alternative or efficient means of gaining exposure to specific investments and markets. Notwithstanding their usefulness, derivatives may also create risks for funds that are separate from the risks associated with the underlying investments, principally leverage risk (i.e., leverage may increase an investment’s potential return but also its potential for larger losses) but also liquidity and counterparty risks.

Currently, an investment company intending to invest in derivatives must comply with the restrictions in Section 18 of the 1940 Act. Section 18, among other things, addresses open- and closed-end investment companies’ capital structures. To protect investors against the potentially adverse effects of excessive leverage, Section 18 restricts the ability of an investment company to issue senior securities, that is bonds, debentures, notes, and similar obligations and instruments that constitute securities and evidence indebtedness. Section 18 also includes two asset-coverage tests applicable to the issuance of senior securities – one for open-end investment companies and another for closed-end investment companies - and it includes special provisions for the issuance by closed-end investment companies of senior securities in the form of preferred stock.[2] An investment company also must navigate the guidance issued by the Staff of the SEC’s Division of Investment Management (the “Staff”) concerning the use of derivatives by investment companies, primarily the Staff’s 1979 general policy statement on certain securities trading practices by investment companies, as well as more than thirty subsequently issued no-action letters.[3] In general, the Staff has permitted investment companies to use derivatives and other types of transactions provided that the funds held back from other uses sufficient portfolio assets to “cover” losses that may result from the transactions.[4]

2015 Derivatives Rule Proposal

In December 2015, the SEC proposed Rule 18f-4. As noted in the 2015 Proposing Release, proposed Rule 18f-4 (2015) was intended by the SEC to replace the patchwork of regulations, no-action letters and other guidance that has governed the use of derivatives by investment companies since the 1980s. If adopted as proposed, proposed Rule 18f-4 (2015) would have permitted investment companies to continue to enter into derivatives transactions and financial commitment transactions but only subject to certain conditions and limitations.

Proposed Rule 18f-4 (2015), among other things, included a three-part framework for the regulation of derivatives use by funds, including (a) new limits on a fund’s exposure to derivatives transactions, (b) new asset segregation requirements to “cover” a fund’s exposure to derivatives, and (c) a requirement that a fund that engages in more than a limited amount of derivatives transactions or use certain complex derivatives establish a “derivatives risk management program” to assess and manage the risks associated with the fund’s derivatives transactions. It also would have required a fund to comply at the time the fund enters into a derivatives transaction with one of two limitations on a fund’s exposure to derivatives transactions and other senior securities - an exposure-based limitation and a risk-based limitation. It also would have required a fund to “cover” its derivatives transactions and financial commitment transactions by segregating on its books at least once each business day assets that meet certain qualifications and conditions. The 2015 Proposing Release also included proposed amendments to SEC reporting forms N-PORT (monthly reports on investment company portfolio holdings) and N-CEN (investment company annual report requiring census-type information), which would have required disclosure to the SEC of information relating to a fund’s use of derivatives.

Comments to the 2015 Proposing Release were many, varied, and highly complex. Generally, however, they reflected the difficulty fund managers had of measuring portfolio leverage across different types of collective investment pools and different investment strategies.

Summary of Proposed Rules (2019)

Re-Proposed Rule 18f-4 (Exemption from Requirements for Certain Senior Securities Transactions)

Proposed Rule 18f-4 (2019), if adopted as re-proposed, would permit a fund to enter into “derivatives transactions,” notwithstanding the prohibitions and restrictions on the issuance of senior securities under Section 18, subject to four principal conditions: limitations on the fund’s leverage risk; adoption of a derivatives risk management program (“DRMP”); oversight by and reporting to the fund’s board of directors or trustees (the “Board”), which includes the appointment of a derivatives risk manager (a “DRM”); and satisfaction of certain recordkeeping requirements. In addition, proposed Rule 18f-4 (2019) includes an exemption from certain requirements that would otherwise apply to funds that are limited users of derivatives, as well as alternative requirements for certain “leveraged/inverse funds.”

Proposed Rule 18f-4 (2019) would define a “derivatives transaction” to mean (a) any swap, security-based swap, futures contract, forward contract, option, any combination of the foregoing, or any similar instrument (“derivative instrument”) under which a fund is or may be required to make any payment or delivery of cash or other assets during the life of the instrument or at maturity or early termination, whether as margin or settlement payment or otherwise, and (b) any short sale borrowing.[5] The Proposing Release notes that although short sales do not involve derivatives instruments, the short sale of a security provides the same economic exposure as a derivative instrument, such as a future or swap.[6]

Limitations on Fund Leverage Risk. Proposed Rule 18f-4 (2019) would require that a fund engaging in derivatives transactions comply with an outer limit on fund leverage risk based on its “value at risk” (“VaR”). The Proposing Release describes VaR as an estimate of a portfolio’s potential losses over a given time horizon at a specified confidence level. VaR is generally determined with the use of a simulation model, and the model’s results are then compared to a reference index that is intended to approximate the VaR of the fund if it did not engage in any derivatives transactions. Proposed Rule 18f-4 (2019) would require that the VaR model used by a fund consider and incorporate all significant, identifiable market risk factors associated with the fund’s investments.[7] The VaR model would be required to use a 99-percent confidence level and a time horizon of 20 trading days. In addition, the VaR model used would have to be based on at least 3 years of historical market data.[8] The DRM has responsibility to ensure that the VaR model used by a fund is appropriate for the fund and its specific investments.

Relative VaR Testing. A fund would comply with the relative VaR test if its VaR does not exceed 150 percent of the VaR of its “designated reference index.”[9] A fund’s designated reference index must be, among other things, unleveraged and it must reflect the markets or asset classes in which the fund invests. It also must either be the “appropriate broad-based securities market index” or “additional index” used by the fund pursuant to Item 27 of Form N-1A.

Absolute VaR Testing. If the DRM is not able to identify an appropriate designated reference index for a fund, the fund would have to comply with an absolute VaR test. In order to comply with the absolute VaR test, the VaR of a fund’s portfolio must not exceed 15 percent of the fund’s net assets.

Daily Testing; Non-Compliance Remediation. A fund would be required to ensure that it complies with its applicable VaR test at least once each business day. If a fund was not in compliance with its applicable VaR test, it must be brought back into compliance promptly and no more than 3 business days after the incident. If a fund were not brought back into compliance within 3 business days, (a) the DRM must report to the Board and explain how and by when the DRM reasonably expects the fund to be brought back into compliance, (b) the DRM must analyze the circumstances that caused the fund to be out of compliance for more than 3 business days and update any elements of the DRMP as appropriate to address those circumstances, and (c) the fund may not enter into any derivatives transactions (other than those designed to reduce the fund’s VaR) until the fund has been back in compliance for at least 3 consecutive business days and satisfied the Board reporting requirement and program analysis and updating requirements.

Derivatives Risk Management Program. To rely on proposed Rule 18f-4 (2019), a fund that uses derivatives would be required to have a formal (written) derivatives risk management program (“DRMP”), which would include policies and procedures reasonably designed to manage the fund’s derivatives risks. The DRMP should consider the specific ways in which a fund uses derivatives, and it should be tailored to the particular types of derivatives that the fund uses and the risks that may arise from its derivative use.

To comply with proposed Rule 18f-4 (2019), a DRMP also is required to have the following elements:

Risk Identification and Assessment. The DRMP would have to identify and assess a fund’s derivatives risks, considering the fund’s derivatives transactions and how they may interact with the fund’s other investments. If derivatives are used to mitigate certain risks, the DRMP would need to assess whether the fund’s use of those derivatives has the intended effect of managing those risks. Those risks must include leverage, market, counterparty, liquidity, operational, and legal risks. The DRM also should consider whether there are any other material risks related to the fund’s use of derivatives.[10]

Risk Guidelines. The DRMP would have to provide for the establishment, maintenance, and enforcement of investment, risk management, or related guidelines that provide for quantitative or otherwise measurable criteria, metrics, or thresholds related to a fund’s derivatives risks (“Guidelines”). Among other things, the Guidelines would need to specify levels of the given criteria, metric or threshold that a fund would not normally expect to exceed and the measures that would be taken if they were exceeded.[11]

Stress Testing. The DRMP would have to provide for stress testing of derivatives risks as a means of evaluating the potential for losses to a fund’s portfolio under stressed conditions. The stressed conditions that must be considered should be extreme, but plausible, conditions that could have a significant adverse effect on the fund’s portfolio. The stress tests would also have to consider correlations of market risk factors and resulting payments to derivatives counterparties. Proposed Rule 18f-4 (2019) would allow the DRM to determine how frequently to conduct the stress tests, based on changes in the fund’s investments and market conditions, although the tests are required to be performed at least weekly.

Backtesting. The DRMP would have to provide for backtesting of the fund’s VaR calculation model to ensure its effectiveness. Each business day, the fund would have to compare its actual gain or loss for that day with the VaR the fund had calculated for that day. The backtest would have to be performed with a 99-percent confidence level and over a one-day time horizon, that is, it would be expected that approximately 1 percent of the time there would be an exception in the backtesting results.

Internal Reporting and Escalation. The DRMP would have to report certain matters relating to a fund’s use of derivatives to the fund’s portfolio management and its Board. Among other things, the DRMP would have to identify the circumstances under which the fund must communicate with its portfolio manager about derivatives risk management.[12] The DRM would also be required to communicate material risks to the fund’s portfolio manager and to the Board, as appropriate. The DRM would have to determine when it was appropriate to escalate such reports to the Board and whether it should be at the same time as or after escalation to the portfolio manager.

DRMP Periodic Reviews. The DRM would be required to review the DRMP at least annually to evaluate the DRMP’s effectiveness and to reflect changes in risk over time. This review would also have to evaluate the VaR model and “designated reference index” used by the fund to limit its leverage risk.

Board Oversight and Reporting. Proposed Rule 18f-4 (2019) would require a Board to approve the designation of the DRM. In addition, the DRM would be required to provide a written report to the Board on the DRMP’s implementation and effectiveness. The report to the Board must describe any instances when a fund exceeded its Guidelines and the results of its stress testing. It also must contain an analysis by the DRM with information reasonably necessary for the Board to evaluate the fund’s responses to any instances when it exceeded its Guidelines and/or stress-testing results. These reports must be provided at least annually. Any written report provided to the Board must include a representation to the effect that the DRMP is reasonably designed to manage the fund’s derivatives risks, and the DRMP incorporates all the required elements of proposed Rule 18f-4 (2019). It also would have to include a description of the basis for the representation.[13] After the initial implementation of the DRMP, the report must also address the effectiveness of the DRMP. In addition, the report must include the DRM’s basis for the selection of the “designated reference index” or, if applicable, why the DRM has been unable to identify a designated reference index.

Derivatives Risk Manager. Proposed Rule 18f-4 (2019) would require each fund to designate one or more officers of its investment adviser or, if applicable, sub-adviser, to serve as the fund’s derivatives risk manager (“DRM”). If more than one person is designated, the designees could act as a committee.[14] A portfolio manager may not be designated as the sole DRM. Each designated person would have to be approved by the Board, and the DRM must have direct communication with the Board. A third party cannot serve as a fund’s DRM, however, a DRM may obtain assistance from a third party in carrying out their duties. A DRM must have relevant experience regarding derivatives risk management. A fund must reasonably segregate the functions of the DRMP from portfolio management.[15]

Recordkeeping. Proposed Rule 18f-4 (2019) provides that for certain recordkeeping requirements to allow the SEC, the Board and the fund’s compliance department to evaluate compliance with Rule 18f-4.

Exemption for Limited Users of Derivatives. Recognizing the costs and compliance burdens of complying with proposed Rule 18f-4 (2019), the Proposing Release includes an exemption for limited users of derivatives. A limited user of derivatives is defined in proposed Rule 18f-4 (2019) as either (a) a fund that limits its derivatives exposure to 10 percent of its net assets[16] or (b) a fund that uses derivatives transactions solely to hedge certain currency risks.[17] A limited user of derivatives would be exempt from the DRMP requirement and the VaR-based limit on fund leverage risk, however, it would still be required to adopt and implement policies and procedures reasonably designed to manage its derivatives risks.[18]

Alternative Requirements for Leveraged/Inverse Funds. A “leveraged/inverse investment vehicle” is a fund that seeks, directly or indirectly, to provide investment returns that correspond to the performance of a market index by a specified multiple, or to provide investment returns that have an inverse relationship to the performance of a market index, over a predetermined period of time.[19] Under proposed Rule 18f-4 (2019), a fund would not have to comply with the VaR-based limits on leverage risk if it meets the following conditions: (a) the fund is a “leveraged/inverse investment vehicle,” as defined in the proposed sales practices rule (discussed below); (b) the fund seeks returns of only up to 300 percent of the return (or inverse of the return) of its underlying index (that is, the fund can seek returns or inverse returns of no more than 3 times its underlying index); and (c) the fund discloses in its prospectus that it is not subject to the proposed limits on leverage risk.[20]

Application to Financing Transactions and Unfunded Commitment Agreements

Financing Transactions (including Reverse Repurchase Agreements). Under the Proposing Release, a fund would be allowed to enter into reverse repurchase agreements and similar financing transactions if it complies with Section 18’s asset coverage requirements. The Proposing Release states that these transactions may be treated differently than derivatives transactions because they have the economic effects of a secured borrowing and therefore are more similar to bank borrowings with a known repayment obligation. If a fund would otherwise qualify as a limited derivatives user, reverse repurchase agreements and similar financing transactions, would not have to be considered in calculating the fund’s derivatives exposure. However, if a fund would not be able to rely on the limited derivatives-user exception, any portfolio leveraging effect of reverse repurchase agreements and similar financing transactions would have to be considered in calculating its VaR test. The Proposing Release notes that a fund’s obligation to return securities lending collateral should not be considered as a “similar financing transaction” if the fund reinvests the cash collateral in highly liquid, short-term investments (e.g., money market funds) and it does not sell or otherwise use non-cash collateral to leverage the fund’s portfolio. However, if a fund were to use non-cash collateral to leverage the fund’s portfolio, the collateral should be treated as a “similar financing transaction” and thus included when calculating the fund’s asset coverage ratio under Section 18. With respect to certain other types of financings, such as tender option bonds, the Proposing Release notes that, depending on the facts and circumstances, such financings may be “similar financing transactions” for purposes of the rule, and thus, they must comply with Section 18’s asset coverage requirements.

Unfunded Commitment Agreements. The Proposing Release notes that BDCs and registered closed-end funds may enter into unfunded commitment agreements whereby the fund commits, conditionally or unconditionally, to make a loan to a company or to invest equity in a company in the future. Under proposed Rule 18f-4 (2019), a fund may enter into such unfunded commitment agreements if the fund reasonably believes, at the time it enters into such agreement, that its cash and cash equivalents would allow it to meet its obligations under all of its unfunded commitment agreements at the time they come due. The Proposed Rule would require the fund to take certain factors in account when making this determination, including reasonable expectations with respect to other fund obligations (such as, any obligation to redeem senior securities). A fund, however, may not consider cash that may become available from the sale or disposition of any investment at a price that deviates significantly from the market value of that investment, or from issuing additional equity. For each unfunded commitment agreement that a fund enters into, it must document the basis for its reasonable belief regarding the sufficiency of its cash and cash equivalents to meet its unfunded commitment agreement obligations.

Proposed Amendments to Rule 6c-11 (Exchange-Traded Funds)

The SEC recently adopted Rule 6c-11 under the 1940 Act to permit most ETFs to operate without first obtaining exemptive relief from the SEC.[21] However, Rule 6c-11(c)(4) currently excludes leveraged/inverse ETFs from the types of funds that may rely on Rule 6c-11. In conjunction with proposed Rule 18f-4 (2019), the SEC is proposing amendments to Rule 6c-11 to remove this exclusion. In addition, the SEC is proposing to rescind all exemptive relief previously provided to issuers of leveraged/inverse ETFs. If adopted as proposed, amended Rule 6c-11 would permit all ETF sponsors to launch and operate leveraged/inverse ETFs without exemptive relief, subject only to the conditions and requirements of Rule 6c-11, Rule 18f-4 and the proposed broker-dealer/investment adviser sales practices rules (discussed below).

Exchange Act Rule 15l-2; Advisers Act Rule 211(h)-1 (Investor Due Diligence)

In conjunction with the proposed alternative leverage limit for leveraged/inverse funds, the SEC also has proposed new rules governing sales practices by broker-dealers and investment advisers that are designed to provide additional safeguards to retail investors investing in such products.[22] These rules apply to shares of registered leveraged/inverse mutual funds and ETFs, as well as shares of exchange-listed commodity or currency pools that have similar investment strategies to leveraged/inverse ETFs. Proposed Rule 15l-2 under the Securities Exchange Act of 1934 and proposed Rule 211(h)-1 under the Investment Advisers Act of 1940 would require broker-dealers and investment advisers to exercise due diligence in determining whether to pre-approve the account of a natural person or their legal representatives (“retail investors”) to buy or sell leveraged/inverse investment vehicles.[23] In conducting its due diligence, a broker-dealer or investment adviser would have to gather certain information from a retail investor, including his or her investment objective, time horizon, and estimated liquid net worth, as well as his or her investment experience and knowledge regarding specified investment products. Based on its due diligence, and only if the broker-dealer or investment adviser has a reasonable basis to believe that the customer or client is capable of evaluating the risks associated with these products, may a broker-dealer or investment adviser pre-approve a client’s account for the purchase or sale of shares of leveraged/inverse investment vehicles.

The proposed sales rules would require firms to adopt written policies and procedures regarding compliance with the proposed rules, and they would impose certain recordkeeping requirements. A firm would have to maintain a written record of the investor information that it obtained by conducting the required due diligence, the firm’s written pre-approval of the retail investor’s account for buying and selling shares of leveraged/inverse investment vehicles, and the versions of the firm’s policies and procedures that it adopted under the proposed rules that were in place when it pre-approved or disapproved the transactions.

Amended Reporting Requirements

The Proposing Release includes proposed amendments to three SEC reporting forms currently applicable to investment companies (but not BDCs).[24] Most of the proposed reporting requirements below apply only to investment companies that do not qualify for the limited derivatives-user exception.

If adopted as proposed, amendments to Form N-PORT would require an investment company to report information relating to its exposure to derivative transactions (essentially, those derivatives transactions covered by Rule 18f-4), as well as short sale borrowings. It also would require reporting information relating to the proposed VaR tests required by Rule 18f-4, including any exceptions the fund identified during the reporting period.

The Proposing Release also includes proposed amendments to Form N-LIQUID, which currently is applicable only to open-end investment companies and which is used to report the occurrence of certain liquidity events. Among other things, Form N-Liquid would be renamed Form N-RN, it would apply to any fund that is subject to the relative VaR test or the absolute VaR test, it would continue to be a current report, and it would include information on new reporting events for funds subject to the proposed VaR-based limits on fund leverage risk.[25]

Finally, the Proposing Release includes proposed amendments to Form N-CEN. Among other things, the proposed amendments would require an investment company to identify whether it relied on Rule 18f-4, as well as exceptions to certain requirements under the rule. Among those exceptions are whether the fund was a limited derivatives user and whether the fund is a leveraged/inverse fund. Finally, it would have to identify whether the fund entered into any reverse repurchase agreement or similar financing transactions, or any unfunded commitment agreements.

When Comments Are Due and How to Submit Comments

Under federal law, the public has a right to comment on these proposed rules. The comment period is open for 60 days after the publication of the Proposing Release in the Federal Register. As of the date of this client alert, the Proposing Release had not yet been published in the Federal Register. Comments generally must be submitted through the SEC’s website at

Throughout the Proposing Release, the SEC has asked for comments on a variety of issues, and we would encourage anyone with an interest in this subject to submit comments for the SEC’s consideration.


[1] “Use of Derivatives by Registered Investment Companies and Business Development Companies; Required Due Diligence by Broker-Dealers and Registered Investment Advisers Regarding Retail Customers’ Transactions in Certain Leveraged/Inverse Investment Vehicles,” Release No. IC-33704 (November 25, 2019) [hereinafter, the “Proposing Release”]. Certain rules proposed in the Proposing Release were originally proposed in “Use of Derivatives by Registered Investment Companies and Business Development Companies,” Release No. IC-31933 (December 11, 2015) [hereinafter, the “2015 Proposing Release”].

[2] Section 18(h) of the 1940 Act defines “asset coverage” as “the ratio which the value of the total assets of such issuer, less all liabilities and indebtedness not represented by senior securities, bears to the aggregate amount of senior securities representing indebtedness of such issuer.”

Section 18 generally prohibits a fund from issuing or selling any “senior security” unless it has 300 percent “asset coverage.” In the case of open-end funds, senior securities must be limited to bank-indebtedness whereas closed-end funds are not subject to that limitation. In the case of a closed-end fund that issues senior securities in the form of preferred stock, the investment company may declare dividends upon the preferred stock provided it satisfies a 200-percent asset-coverage test. BDCs are subject to limitation similar, but not identical, to those limitations applicable to closed-end funds.

[3] “Securities Trading Practices of Registered Investment Companies,” Release No. IC-10666 (April 18, 1979) [hereinafter, “Release 10666”]. For a list of Staff interpretative guidance relating to investment company use of derivatives, see “Registered Investment Company Use of Senior Securities – Select Bibliography,” at .

[4] Release 10666 considered whether Section 18’s restrictions on senior securities applied to reverse purchase agreements, firm commitment agreements, and standby commitment agreements. The Staff stated that because these instruments involve a contractual obligation to pay in the future for consideration presently received, these instruments may be considered senior securities. The Staff determined, however, that these and other similar instruments could be appropriately used by funds subject to certain restraints, including a requirement that funds “cover” senior securities by maintaining segregated accounts with sufficient portfolio assets to cover potential losses attributable to those instruments.

[5] The Proposing Release notes that not all derivative instruments would involve the issuance of a senior security, only those that “evidence indebtedness”. An example of such a derivative would be a standard option traded on an exchange, for which the fund would make a non-refundable premium payment to obtain the right to acquire (or sell) securities under the option, but it would not have any further obligation to deliver cash or assets to the counterparty unless the fund would choose to exercise the option.

Part (a) of the proposed definition is intended to describe those types of derivatives transactions that involve the issuance of a senior security because they contractually require, or may require, a future payment obligation. Moreover, it is intended to cover the types of derivatives currently being used, but derivatives that may be developed in the future that would be otherwise be prohibited by Section 18. Part (b) includes short sale borrowings as the value of a short position is derived from the price of another asset, that is, the value of the asset sold short.

[6] The Proposing Release notes that a firm commitment agreement provides the same economic exposure as a forward contract and a standby commitment agreement provides the same economic exposure as an option contract and therefore these would be included under “any similar instrument”.

[7] The Proposed Rule includes a non-exhaustive list of common market risk factors that a fund must account for in its VaR model if applicable: (a) equity price risk, interest rate risk, credit spread risk, foreign currency risk and commodity price risk; (b) material risks arising from the nonlinear price characteristics of a fund’s investments, including options and positions with embedded optionality; and (c) the sensitivity of the market value of the fund’s investments to changes in volatility.

[8] One notable difference from proposed Rule 18f-4 (2015) is that a fund would not be required to apply its VaR model consistently when calculating the VaR of the fund versus the VaR of the designated reference index.

[9] The Proposing Release notes that 150 percent was selected because that would effectively limit a fund’s leverage risk related to the use of derivatives transactions in the same way that Section 18 limits the ability of a fund to borrow from a bank.

[10] The Proposing Release notes, as an example of another material risk, political risk if an event could impact currencies.

[11] The Proposing Release notes that this requirement was designed to address the derivatives risks that a fund should be monitoring on an ongoing basis as part of the DRMP and to help the fund identify when it should respond to changes in those risks. Proposed Rule 18f-4 (2019) does not prescribe any one approach for the Guidelines but allows each fund to tailor them to its own use of derivatives. The Proposing Release notes certain examples that funds may wish to use in creating their Guidelines, such as having lists of approved transactions for the fund and using quantitative models to measure the risks associated with the fund’s use of derivatives. The Proposing Release also notes that a fund should consider how to create and maintain its Guidelines in light of its investment portfolio and disclosure to investors.

[12] The Proposing Release notes as examples that a DRMP could require that the DRM meet with the fund’s portfolio manager on a regular, frequent basis or could require that the fund’s portfolio manager be notified of stress testing results through automated updates.

[13] The Proposing Release notes that the DRM’s representation may be based on their reasonable belief after due inquiry.

[14] This is a change from the 2015 proposal, where it would have been required for a single person to serve as a fund’s DRM and portfolio managers would not have been allowed to provide input into a fund’s DRMP.

[15] The Proposing Release notes that the reasonable segregation requirement is not meant to indicate that the DRM and portfolio management must be subject to a communications firewall.

[16] The Proposing Release notes that “derivatives exposure” means the sum of the notional amounts of the fund’s derivatives instruments, and for short sale borrowings, the value of any asset sold short. However, in determining derivatives exposure a fund may convert the notional amount of interest rate derivatives to 10-year bond equivalents and delta adjust the notional amounts of options contracts.

[17] Under this exception, a fund could only use currency derivatives to hedge currency risk associated with specific foreign-currency denominated equity or fixed income investments in the fund’s portfolio. In addition, the notional amount of the currency derivatives could not exceed the value of the instruments denominated in the foreign currency by more than a negligible amount.

[18] In this instance, the derivatives risks that must be considered in designing the policies and procedures must be the same as those required under a fund’s DRMP, but the investment adviser, rather than the DRM, must consider whether there are any other material risks related to the use of derivatives that should be considered.

[19] The definition of “leveraged/inverse investment vehicles” is incorporated by reference to the “sales practices rules” described below.

A handful of exchange-traded funds (ETFs) currently qualify as leveraged/inverse investment vehicles, and they have attracted substantial assets. Since the 2009 financial crisis, however, the SEC has not granted the exemptive relief necessary to permit the operation of newly formed leveraged/inverse ETFs.

Most leveraged/inverse funds provide leveraged or inverse market exposure exceeding 150 percent of the return or inverse return of the relevant index. As a result, these funds would fail the relative VaR test and they would not be eligible to use the absolute VaR test.

[20] The proposed rule described in the 2015 Proposing Release would have been incompatible with the continued operation of leveraged/inverse funds because of the proposed overall limits on fund leverage, as described above.

[21] A copy of our September 2019 client alert relating to the adoption of Rule 6c-11 may be found here: .

[22] The Proposing Release notes that these requirements are modeled, in large part, on the FINRA rules requiring due diligence and account approval for retail investors to trade in options. In addition, the Proposing Release notes that compliance with these sales practice rules would not supplant or by itself satisfy other broker-dealer or investment adviser obligations, such as broker-dealer obligations under Regulation Best Interest or an investment adviser’s fiduciary duty.

[23] Notably, the proposed rules would not exclude high-net worth individuals from the types of retail investors for which pre-approval would be required before they are able to transact in leveraged/inverse funds.

[24] BDCs currently do not file reports on Form N-PORT or Form N-CEN. As noted in the Proposing Release, BDCs generally do not enter into derivatives transactions, or if they do, only to a limited extent. As a result, the Proposing Release does not propose any specific reporting obligations of BDCs relating to their derivatives exposure.

[25] The Proposing Release also includes a proposed amendment to Rule 30b1-10 under the 1940 Act. That amendment would reflect proposed Rule 18f-4 (2019)’s requirement that all funds that are subject to the relative VaR test or absolute VaR test must file current reports regarding certain VaR test breaches.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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Other Information: We also collect other information you may voluntarily provide. This may include content you provide for publication. We may also receive your communications with others through our Website and Services (such as contacting an author through our Website) or communications directly with us (such as through email, feedback or other forms or social media). If you are a subscribed user, we will also collect your user preferences, such as the types of articles you would like to read.

Information from third parties (such as, from your employer or LinkedIn): We may also receive information about you from third party sources. For example, your employer may provide your information to us, such as in connection with an article submitted by your employer for publication. If you choose to use LinkedIn to subscribe to our Website and Services, we also collect information related to your LinkedIn account and profile.

Your interactions with our Website and Services: As is true of most websites, we gather certain information automatically. This information includes IP addresses, browser type, Internet service provider (ISP), referring/exit pages, operating system, date/time stamp and clickstream data. We use this information to analyze trends, to administer the Website and our Services, to improve the content and performance of our Website and Services, and to track users' movements around the site. We may also link this automatically-collected data to personal information, for example, to inform authors about who has read their articles. Some of this data is collected through information sent by your web browser. We also use cookies and other tracking technologies to collect this information. To learn more about cookies and other tracking technologies that JD Supra may use on our Website and Services please see our "Cookies Guide" page.

How do we use this information?

We use the information and data we collect principally in order to provide our Website and Services. More specifically, we may use your personal information to:

  • Operate our Website and Services and publish content;
  • Distribute content to you in accordance with your preferences as well as to provide other notifications to you (for example, updates about our policies and terms);
  • Measure readership and usage of the Website and Services;
  • Communicate with you regarding your questions and requests;
  • Authenticate users and to provide for the safety and security of our Website and Services;
  • Conduct research and similar activities to improve our Website and Services; and
  • Comply with our legal and regulatory responsibilities and to enforce our rights.

How is your information shared?

  • Content and other public information (such as an author profile) is shared on our Website and Services, including via email digests and social media feeds, and is accessible to the general public.
  • If you choose to use our Website and Services to communicate directly with a company or individual, such communication may be shared accordingly.
  • Readership information is provided to publishing law firms and authors of content to give them insight into their readership and to help them to improve their content.
  • Our Website may offer you the opportunity to share information through our Website, such as through Facebook's "Like" or Twitter's "Tweet" button. We offer this functionality to help generate interest in our Website and content and to permit you to recommend content to your contacts. You should be aware that sharing through such functionality may result in information being collected by the applicable social media network and possibly being made publicly available (for example, through a search engine). Any such information collection would be subject to such third party social media network's privacy policy.
  • Your information may also be shared to parties who support our business, such as professional advisors as well as web-hosting providers, analytics providers and other information technology providers.
  • Any court, governmental authority, law enforcement agency or other third party where we believe disclosure is necessary to comply with a legal or regulatory obligation, or otherwise to protect our rights, the rights of any third party or individuals' personal safety, or to detect, prevent, or otherwise address fraud, security or safety issues.
  • To our affiliated entities and in connection with the sale, assignment or other transfer of our company or our business.

How We Protect Your Information

JD Supra takes reasonable and appropriate precautions to insure that user information is protected from loss, misuse and unauthorized access, disclosure, alteration and destruction. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. You should keep in mind that no Internet transmission is ever 100% secure or error-free. Where you use log-in credentials (usernames, passwords) on our Website, please remember that it is your responsibility to safeguard them. If you believe that your log-in credentials have been compromised, please contact us at

Children's Information

Our Website and Services are not directed at children under the age of 16 and we do not knowingly collect personal information from children under the age of 16 through our Website and/or Services. If you have reason to believe that a child under the age of 16 has provided personal information to us, please contact us, and we will endeavor to delete that information from our databases.

Links to Other Websites

Our Website and Services may contain links to other websites. The operators of such other websites may collect information about you, including through cookies or other technologies. If you are using our Website or Services and click a link to another site, you will leave our Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We are not responsible for the data collection and use practices of such other sites. This Policy applies solely to the information collected in connection with your use of our Website and Services and does not apply to any practices conducted offline or in connection with any other websites.

Information for EU and Swiss Residents

JD Supra's principal place of business is in the United States. By subscribing to our website, you expressly consent to your information being processed in the United States.

  • Our Legal Basis for Processing: Generally, we rely on our legitimate interests in order to process your personal information. For example, we rely on this legal ground if we use your personal information to manage your Registration Data and administer our relationship with you; to deliver our Website and Services; understand and improve our Website and Services; report reader analytics to our authors; to personalize your experience on our Website and Services; and where necessary to protect or defend our or another's rights or property, or to detect, prevent, or otherwise address fraud, security, safety or privacy issues. Please see Article 6(1)(f) of the E.U. General Data Protection Regulation ("GDPR") In addition, there may be other situations where other grounds for processing may exist, such as where processing is a result of legal requirements (GDPR Article 6(1)(c)) or for reasons of public interest (GDPR Article 6(1)(e)). Please see the "Your Rights" section of this Privacy Policy immediately below for more information about how you may request that we limit or refrain from processing your personal information.
  • Your Rights
    • Right of Access/Portability: You can ask to review details about the information we hold about you and how that information has been used and disclosed. Note that we may request to verify your identification before fulfilling your request. You can also request that your personal information is provided to you in a commonly used electronic format so that you can share it with other organizations.
    • Right to Correct Information: You may ask that we make corrections to any information we hold, if you believe such correction to be necessary.
    • Right to Restrict Our Processing or Erasure of Information: You also have the right in certain circumstances to ask us to restrict processing of your personal information or to erase your personal information. Where you have consented to our use of your personal information, you can withdraw your consent at any time.

You can make a request to exercise any of these rights by emailing us at or by writing to us at:

Privacy Officer
JD Supra, LLC
10 Liberty Ship Way, Suite 300
Sausalito, California 94965

You can also manage your profile and subscriptions through our Privacy Center under the "My Account" dashboard.

We will make all practical efforts to respect your wishes. There may be times, however, where we are not able to fulfill your request, for example, if applicable law prohibits our compliance. Please note that JD Supra does not use "automatic decision making" or "profiling" as those terms are defined in the GDPR.

  • Timeframe for retaining your personal information: We will retain your personal information in a form that identifies you only for as long as it serves the purpose(s) for which it was initially collected as stated in this Privacy Policy, or subsequently authorized. We may continue processing your personal information for longer periods, but only for the time and to the extent such processing reasonably serves the purposes of archiving in the public interest, journalism, literature and art, scientific or historical research and statistical analysis, and subject to the protection of this Privacy Policy. For example, if you are an author, your personal information may continue to be published in connection with your article indefinitely. When we have no ongoing legitimate business need to process your personal information, we will either delete or anonymize it, or, if this is not possible (for example, because your personal information has been stored in backup archives), then we will securely store your personal information and isolate it from any further processing until deletion is possible.
  • Onward Transfer to Third Parties: As noted in the "How We Share Your Data" Section above, JD Supra may share your information with third parties. When JD Supra discloses your personal information to third parties, we have ensured that such third parties have either certified under the EU-U.S. or Swiss Privacy Shield Framework and will process all personal data received from EU member states/Switzerland in reliance on the applicable Privacy Shield Framework or that they have been subjected to strict contractual provisions in their contract with us to guarantee an adequate level of data protection for your data.

California Privacy Rights

Pursuant to Section 1798.83 of the California Civil Code, our customers who are California residents have the right to request certain information regarding our disclosure of personal information to third parties for their direct marketing purposes.

You can make a request for this information by emailing us at or by writing to us at:

Privacy Officer
JD Supra, LLC
10 Liberty Ship Way, Suite 300
Sausalito, California 94965

Some browsers have incorporated a Do Not Track (DNT) feature. These features, when turned on, send a signal that you prefer that the website you are visiting not collect and use data regarding your online searching and browsing activities. As there is not yet a common understanding on how to interpret the DNT signal, we currently do not respond to DNT signals on our site.

Access/Correct/Update/Delete Personal Information

For non-EU/Swiss residents, if you would like to know what personal information we have about you, you can send an e-mail to We will be in contact with you (by mail or otherwise) to verify your identity and provide you the information you request. We will respond within 30 days to your request for access to your personal information. In some cases, we may not be able to remove your personal information, in which case we will let you know if we are unable to do so and why. If you would like to correct or update your personal information, you can manage your profile and subscriptions through our Privacy Center under the "My Account" dashboard. If you would like to delete your account or remove your information from our Website and Services, send an e-mail to

Changes in Our Privacy Policy

We reserve the right to change this Privacy Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our Privacy Policy will become effective upon posting of the revised policy on the Website. By continuing to use our Website and Services following such changes, you will be deemed to have agreed to such changes.

Contacting JD Supra

If you have any questions about this Privacy Policy, the practices of this site, your dealings with our Website or Services, or if you would like to change any of the information you have provided to us, please contact us at:

JD Supra Cookie Guide

As with many websites, JD Supra's website (located at (our "Website") and our services (such as our email article digests)(our "Services") use a standard technology called a "cookie" and other similar technologies (such as, pixels and web beacons), which are small data files that are transferred to your computer when you use our Website and Services. These technologies automatically identify your browser whenever you interact with our Website and Services.

How We Use Cookies and Other Tracking Technologies

We use cookies and other tracking technologies to:

  1. Improve the user experience on our Website and Services;
  2. Store the authorization token that users receive when they login to the private areas of our Website. This token is specific to a user's login session and requires a valid username and password to obtain. It is required to access the user's profile information, subscriptions, and analytics;
  3. Track anonymous site usage; and
  4. Permit connectivity with social media networks to permit content sharing.

There are different types of cookies and other technologies used our Website, notably:

  • "Session cookies" - These cookies only last as long as your online session, and disappear from your computer or device when you close your browser (like Internet Explorer, Google Chrome or Safari).
  • "Persistent cookies" - These cookies stay on your computer or device after your browser has been closed and last for a time specified in the cookie. We use persistent cookies when we need to know who you are for more than one browsing session. For example, we use them to remember your preferences for the next time you visit.
  • "Web Beacons/Pixels" - Some of our web pages and emails may also contain small electronic images known as web beacons, clear GIFs or single-pixel GIFs. These images are placed on a web page or email and typically work in conjunction with cookies to collect data. We use these images to identify our users and user behavior, such as counting the number of users who have visited a web page or acted upon one of our email digests.

JD Supra Cookies. We place our own cookies on your computer to track certain information about you while you are using our Website and Services. For example, we place a session cookie on your computer each time you visit our Website. We use these cookies to allow you to log-in to your subscriber account. In addition, through these cookies we are able to collect information about how you use the Website, including what browser you may be using, your IP address, and the URL address you came from upon visiting our Website and the URL you next visit (even if those URLs are not on our Website). We also utilize email web beacons to monitor whether our emails are being delivered and read. We also use these tools to help deliver reader analytics to our authors to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

Analytics/Performance Cookies. JD Supra also uses the following analytic tools to help us analyze the performance of our Website and Services as well as how visitors use our Website and Services:

  • HubSpot - For more information about HubSpot cookies, please visit
  • New Relic - For more information on New Relic cookies, please visit
  • Google Analytics - For more information on Google Analytics cookies, visit To opt-out of being tracked by Google Analytics across all websites visit This will allow you to download and install a Google Analytics cookie-free web browser.

Facebook, Twitter and other Social Network Cookies. Our content pages allow you to share content appearing on our Website and Services to your social media accounts through the "Like," "Tweet," or similar buttons displayed on such pages. To accomplish this Service, we embed code that such third party social networks provide and that we do not control. These buttons know that you are logged in to your social network account and therefore such social networks could also know that you are viewing the JD Supra Website.

Controlling and Deleting Cookies

If you would like to change how a browser uses cookies, including blocking or deleting cookies from the JD Supra Website and Services you can do so by changing the settings in your web browser. To control cookies, most browsers allow you to either accept or reject all cookies, only accept certain types of cookies, or prompt you every time a site wishes to save a cookie. It's also easy to delete cookies that are already saved on your device by a browser.

The processes for controlling and deleting cookies vary depending on which browser you use. To find out how to do so with a particular browser, you can use your browser's "Help" function or alternatively, you can visit which explains, step-by-step, how to control and delete cookies in most browsers.

Updates to This Policy

We may update this cookie policy and our Privacy Policy from time-to-time, particularly as technology changes. You can always check this page for the latest version. We may also notify you of changes to our privacy policy by email.

Contacting JD Supra

If you have any questions about how we use cookies and other tracking technologies, please contact us at:

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This website uses cookies to improve user experience, track anonymous site usage, store authorization tokens and permit sharing on social media networks. By continuing to browse this website you accept the use of cookies. Click here to read more about how we use cookies.