T. Rowe Price Adapts to SEC Rule 18f-4

When the U.S. Securities and Exchange Commission (SEC) proposed a new rule designed to enhance the regulation of the use of derivatives by registered investment companies, the Commission has given funds a compliance transition period of 18 months.

The Rule 18f-4 took effect on February 19, 2021, but funds have until mid-August of 2022 to demonstrate that they are aligned with the new regime.

Jonathan Siegel, Senior Legal Counsel, Legislative & Regulatory Affairs, T. Rowe Price, said: “We are pleased the SEC’s final rule addressed several key concerns that industry had with the proposed version, including increasing the relative and absolute VaR limits to 200% and 20%, respectively. The rule takes a more holistic approach to oversight of funds’ derivatives use as compared to the existing section 18 framework.”

“We anticipate the full requirements of the rule will apply to many of our fixed income funds. That said, we don’t anticipate material changes in terms of how any of our funds are managed as a result of the rule,” he told Traders Magazine.

According to Stephen Bruel, Head of Derivatives and FX, Market Structure and Technology, what’s notable is that years after the financial crisis and after significant changes across the derivatives market, the industry is still dealing with an evolving regulatory landscape. 

“Rule 18f-4 in and of itself requires new policies at asset managers, but needs to be accommodated at the same time as other issues such as Uncleared Margin Rules and changes to the security-based swaps market,” he said.

“The totality of the regulatory changes will meaningfully affect the derivatives program and the derivatives trade lifecycle, necessitating a comprehensive and coordinated approach from an asset manager,” he told Traders Magazine.

According to Siegel, being able to systematically monitor which funds are able to utilize the limited derivatives user exception will help some fund shops reduce the universe of funds that need to have a formal derivatives risk management program and conduct VaR testing. 

“We have a critical mass of funds that are expected to be subject to the full rule, so we don’t expect much in the way of incremental costs as other funds become subject to the program over time,” he said.

For funds affected by this SEC rule change, the goal is the same: adapting whatever regulatory reporting approach or platform they are currently using to accommodate the change, according to an eGuide “Adapting Smoothly to SEC Rule 18f-4” by Confluence Technologies.

“Challenges arise as firms and funds try to minimize the operational disruption and additional costs these regulatory changes can cause,” the eGuide said.

What funds need is adaptability in their compliance and reporting programs, the eGuide said.

“Whether that adaptability comes as part of a compliance platform that they deploy, or is reflected in their service provider’s offerings, efficient adaptability is critical to success in today’s changing compliance landscape.”

Siegel told Traders Magazine that T. Rowe Price’s Compliance and Risk professionals are working closely together on implementation of the rule.

“An important component of this works relates to documenting key aspects of the derivatives risk management program in formal policies and procedures,” he stressed.

“We use a mix of internal and external resources in connection with similar VaR requirements in other jurisdictions. At this point, we don’t anticipate needing to retain additional providers as a result of this rule,” he added.

Siegel believes that taking a project management approach is particularly useful for a multi-faceted rule like 18f-4. 

“We also think good communication with the fund board will be key, given directors’ ongoing oversight obligations and responsibility for approving the derivatives risk manager,” he concluded.