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SEBI Limits Mutual Fund’s Exposure to Derivatives

 

 

The Securities and Exchange Board of India (SEBI) has barred mutual funds from writing options or purchase instruments with embedded writer options.
 

The market regulator has also asked fund houses that the total exposure related to option premium paid should not exceed 20 per cent of the net assets of the scheme.

 

The move reiterates that the primary purpose of investment by mutual funds in derivatives is to mitigate risk and not to make profits from such exposures.
 

The existing norms allow mutual funds to invest in derivatives in a manner similar to foreign institutional investors. However, the current regulations do not put any cap on the notional exposure that the mutual funds may take in derivatives as a percentage of their net assets.

 

A circular issued by SEBI on Wednesday on norms for investment and disclosure by mutual funds in derivatives says that the cumulative gross exposure through equity, debt and derivatives should not exceed 100 per cent of the net assets of the scheme.

 

However, it excludes cash or cash equivalents with residual maturity of less than 91 days and exposure due to hedging positions from the above mentioned limits.

 

The new norms allow mutual funds to enter into plain vanilla interest rate swaps for hedging purposes. The counter party in such transactions has to be an entity recognised as a market maker by the Reserve Bank of India. The value of the notional principal in such cases must not exceed the value of respective existing assets being hedged by the scheme. Exposure to a single counterparty in such transactions should not exceed 10 per cent of the net assets of the scheme.

 

The circular further prescribes a particular format for the purpose of uniform disclosure of investments in derivative instruments by mutual funds in half yearly portfolio disclosure, annual report or in any other disclosures.

 

The new norms will be applicable for all new schemes launched after the issue of the circular. All existing schemes should comply with the norms by October 01, 2010.

 

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