CCO Resource Center: Derivatives (Rule 18f-4) Policies and Procedures
Chief Compliance Officer Committee
Derivatives (Rule 18f-4) Policies and Procedures
In November 2020, the SEC adopted a new rule (Rule 18f-4) and rule amendments under the Investment Company Act of 1940 to govern the regulation of mutual funds and similar instruments by mutual funds, exchange-traded funds, and business development companies. The new rule requires funds that use derivatives, other than on a limited basis, to adopt a derivatives risk management program with policies and procedures that are reasonably designed to manage the fund’s derivatives risks. The program must be administered by a Derivatives Risk Manager (DRM) with relevant experience regarding derivatives risk management and the program must be overseen by the fund’s board of directors. Funds must also adhere to a Value-at-Risk-based (VaR) outer limit on fund leverage risk. Limited derivative users are not subject to these requirements, but they are required to adopt and implement policies and procedures reasonably designed to manage the fund’s derivatives risks.
As regards a fund’s Derivatives Risk Management Program, Rule 18f-4 requires it to include each of the following elements, which must be tailored to the funds’ derivatives use and their associated risks: Risk Identification and Assessment; Risk Guidelines; Stress Testing; Back Testing; Internal Reporting and Escalation; and a Periodic Review. Each of these elements is discussed in more detail in ICI Memo No. 32886 (November 2, 2020), which was published following the rule’s adoption and is available through this link: https://www.ici.org/memo32886,
With respect to members’ DRMs, an informal survey conducted of ICI’s CCO Committee in May 2022 (prior to the rule’s compliance date) indicated that approximately 42% of survey participants were expecting their boards to appoint a single officer to serve as the DRM. The remaining 58% were expected to have multiple persons serve as the DRM.
Subsequent to the rule’s adoption, members adopted the necessary policies and procedures required by the rule. We asked members to share with us the policies and procedures they adopted so other ICI members could use them as a resource when drafting or revising their own policies and procedures. These policies and procedures, which are arranged in order of their length (from shortest to longest) are available through the link below. As more policies are shared with us, they will be added to this compilation.
The documentation provided by ICI that may be accessed by committee and task force members is restricted to members use only and not for distribution or reproduction. Documentation may be used internally at member organizations as needed to facilitate committee and task force initiatives.