Lesson 9 of 25 · 6 min
Issuer and sector limits, and how they aggregate
Four separate holdings can be one exposure, and the caps are written against the exposure rather than against the line items.
A concentration cap is only as meaningful as the thing it is measured against, and a lender does not measure positions. It measures exposures, which is a different unit.
An issuer limit aggregates everything that references the same company. Common stock and a second share class are one exposure. A convertible bond of the same issuer is the same exposure again, because in the scenario that matters both are impaired by the same announcement. Where a schedule permits it, an option position on the name is folded in on a delta-adjusted basis.
Some schedules go further and look through funds. A broad-market index fund is generally left alone, on the grounds that any single holding inside it is a small fraction. A narrow sector fund is a different matter: if 11 percent of it sits in the same issuer the borrower already holds directly, that 11 percent is added to the issuer exposure. Sector limits then aggregate a level higher, across different issuers in one category.
The practical result is that the cap can bite at a number the borrower has never computed. Four holdings of $214,000, $96,500, $140,000 and a fund sleeve of $41,800 are, on any statement, four unrelated lines of which the largest is $214,000. Inside the lender's system they are one line of $492,300, and it is that figure the 22 percent cap is compared against.
Key terms
- Issuer exposure
- Everything in the account whose value depends on one company, added together regardless of instrument. The unit a concentration cap is measured in.
- Look-through
- Attributing a fund's underlying holdings to the borrower for limit purposes. Usually applied to narrow sector funds and not to broad ones.
- Sector limit
- A cap applied one level above the issuer, across every company in a category, for the same reason issuer limits exist.
Worked example
Four lines, one exposure
A $1,920,000 eligible account. The issuer cap is 22 percent of eligible market value, with the excess credited at zero.
- Common stock of the issuer
- $214,000
- A second share class of the same issuer
- $96,500
- A convertible bond of the same issuer
- $140,000
- Sector fund sleeve, 11% of a $380,000 holding
- $41,800
- Aggregate issuer exposure
- $492,300
- Excess above the cap, credited at zero
- $69,900
$380,000 × 0.11.
25.6% of the account.
$492,300 less $422,400.
No individual line came close to the cap. The aggregate breached it by $69,900, and the arithmetic that produced the breach appears on no statement.
Check yourself
A $1,500,000 eligible account holds two share classes of one company worth $180,000 and $62,500, a convertible bond of the same issuer at $88,000, and a sector fund position of $250,000 that is 9 percent in that issuer. The issuer cap is 20 percent. Is it breached?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.