Given recent developments in the U.S. financial markets, we would like to take this opportunity to remind our clients with retail mutual funds that hold derivative positions of the following prudent practices:
- You should monitor on a daily basis the credit rating of your counterparty or its guarantor, if any. If the credit rating of the applicable equivalent debt falls below the level of approved credit rating set out in National Instrument 81-102, the mutual fund is required to take steps to close out its position in the derivative in an orderly and timely fashion.
- You should also monitor on a daily basis the mark-to-market value of the exposure of your mutual funds under their derivative positions with each counterparty to ensure that each fund has not exceeded the 10 percent limitation. For the purposes of this calculation, we note that the netting provisions in the ISDA master agreement and schedule are very limited.
Although the derivative provisions of National Instrument 81-102 only apply to retail mutual funds, many closed-end investment funds and other types of investment funds have adopted similar provisions and therefore managers of those funds need to be aware of these issues. You should also review the terms of your ISDA documentation to determine what your rights are in the event of a downgrade or other event affecting your counterparties.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.