Hedging Derivatives Under Rule 18f-4: Not An "All Or None" Exclusion

This post will address another ambiguity in the "10% buffer" Rule 18f-4 provides for excluding the notional amount of derivative transactions that hedge currency or interest rate risks ("Hedging Derivatives") when calculating the Derivatives Exposure of a Limited Derivatives User. The ambiguity is whether, once the notional amount of a Hedging Derivative exceeds the 10% buffer, a fund should add back to its Derivatives Exposure (a) the entire notional amount of the Hedging Derivative or (b) only the notional amount in excess of the 10% buffer. We chose answer (b) in our post on The 10% Buffer and Changes in Hedged Investments. This post explains why.

The Problematic Situation

In our earlier post, we posited a situation in which a fund had sold 80 of the September 2022 Euro FX Futures to hedge equity investments with a value of €10 million, which then fell to €9 million. As Euro FX Futures have a notional amount of €125,000, 72 contracts would now be sufficient to