Know Your Limits
Under the Derivatives Rule, funds are subject to a leverage limit of 200%, based on Value at Risk (VaR) calculations of a designated benchmark or 20% of the fund’s net assets using an absolute VaR test. As a result, previously approved 300% leveraged ETFs have been grandfathered and any future leveraged ETF will need to comply with the 200% limit. Funds that limit their derivatives use to 10% of their net assets are exempt from the VaR test limits. Additionally, there are exemptions for currency and interest-rate hedging.
A critique of the revised proposal was that certain elements were out of step with the Undertakings for the Collective Investment in Transferable Securities (UCITS) derivatives rules. However, the final rule has corrected this and introduces leverage limits that are in line with the UCITS derivatives rules. Now, similar to the UCITS derivative rules, it allows a fund to measure its VaR against its investment strategy, rather than against a general index. Asset managers welcome this harmonization, as it will make it easier to manage derivatives programs across their global fund ranges. This is another example of the recent cross-pollination between the US and EU regulators. “The US liquidity rules also borrowed from the UCITS tool kit by allowing funds to deploy swing-pricing,” says Kelli O’Brien, Director of Fund Administration at Citi Securities Services. “For an industry that is increasingly global, this sort of incremental harmonization creates a framework for firms to maintain a more unified operating model, which can help control costs.”