SEBI seeks to regulate fund investment & disclosure in derivatives
April 29, 2010
Market watchdog Securities and Exchange Board of India (SEBI) has sought views from mutual funds on the proposed circular which tweaks certain clauses of its earlier orders in order to bring more transparency and clarity in disclosure of MFs’ investment in derivatives in their portfolio statements. The draft circular was sent to all the chief general managers and investment managers of fund houses on 25 March 2010. Moneylife possesses a copy of the draft circular sent to all asset management companies (AMCs). If approved by fund houses, the earlier format prescribed by SEBI in its circular dated 24 November 2000 will be discussed, and modified to include the new format.
The latest circular limits the gross cumulative exposure of MFs through debt, equity and derivatives positions to 100% and option premium paid to 20% of the net assets of the scheme. It cannot exceed the prescribed limits.
Exposure in derivatives due to hedging may not be included in the above prescribed limit, only if such exposure reduces losses. Cash or cash equivalents with residual maturity of less than 91 days will not be included in this limit. Further hedging cannot be done for existing derivatives positions; if done, then it will be included in the above mentioned limit. The derivatives instrument used to hedge has to have the same underlying security as the existing position being hedged. The quantity of underlying security associated with the derivatives position taken for hedging purposes should not exceed the quantity of the existing position against which hedge has been taken. Exposure due to derivative positions taken for hedging in excess of the underlying position against which the hedging position has been taken will also be included in the 100% gross exposure limit.
MFs can enter into plain vanilla interest rate swaps for hedging and the value of the notional principal must not exceed the value of respective existing assets being hedged by the scheme.
The circular also outlines certain modifications pertaining to derivatives position computing. Currently the manner of half-yearly portfolio derivatives disclosure is not uniform across the industry as the SEBI (MF) Regulations, 1996, do not specifically prescribe a format for such disclosures.
SEBI has also asked MFs to separately disclose the hedging positions through swaps as two notional positions in the underlying security with relevant maturities. “For example, an interest rate swap under which a mutual fund is receiving floating rate interest and paying fixed rate will be treated as a long position in a floating rate instrument of maturity equivalent to the period until the next interest fixing and a short position in a fixed rate instrument of maturity equivalent to the residual life of the swap,” states the draft circular. MFs will also not write options or purchase instruments with embedded written options. Further, while listing net assets, the margin amounts paid should be reported separately under cash or bank balances.
Following the recommendations of the Secondary Market Advisory Committee, SEBI’s circular dated 14 September 2005 permitted MFs to participate in the derivatives market at par with foreign institutional investors (FIIs) in respect to position limits in index futures, index options, stock options and stock futures contracts. The SEBI circular dated 19 September 2002 included disclosures related to equity and debt schemes. — Moneylife Digital Team