Rule 18f-4 (SEC, Use of Derivatives)

The below is copied from the SEC website.

Limits on Value-at-Risk (VaR)

  • Any appropriate VaR methodology
    • VaR methodology adopted should account for equity price risk, interest rate risk, credit (spread) risk, (foreign) currency risk, etc.
    • Modelling should account for non-linear movements in securities, e.g. options and also  volatility effects.
  • VaR metric: 
    • With 99% confidence,
    • Over 20 business days, and with 
    • 3 years of data
  • Relative VaR (against reference portfolio/benchmark ~ if appropriate)
    • VaR limit at 200% the reference portfolio)
  • Absolute VaR
    • VaR limit at 20% the portfolio value

If the above limits are breached for 5 business days, this must be reported to portfolio management with corrective steps proposed/implemented. 

Require a risk management program as well appointing a derivatives risk manager

Various reporting is required (to SEC & others)

Exceptions are available

  • If an exception is gained, the derivative exposure must remain below 10% the portfolio value

Additional requirements

  • Identify derivative securities & their risks
  • Guidelines must be available for the derivative(s) risk
  • Stress testing must be performed on the portfolio
  • Backtesting must be performed on the portfolio 


About alundarwood

I am involved in market risk and performance analytics in the financial services industry. My expertise includes portfolio management, fixed income analysis, advanced derivative pricing and building software valuation models.
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