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  • MF News SEBI announces new MF norms for derivatives investment and disclosure

    SEBI announces new MF norms for derivatives investment and disclosure

    The market regulator SEBI issued new norms for MFs to invest in derivatives. What are they?
    Team Cafemutual Aug 18, 2010

    The market regulator SEBI issued new norms for MFs to invest in derivatives. What are they?

    Mumbai: New regulations restrict the cumulative gross exposure through equity, debt and derivative positions to 100 per cent and also limit option premium exposure to 20 per cent of the net asset value of a scheme. This cap would restrict the extent of hedging positions a mutual fund takes.

    The regulator, Securities and Exchange Board of India (SEBI), has banned MFs from selling options and purchasing instruments with embedded options. This move is intended to limit the exposure as the option writer undertakes unlimited loss as compared to an option buyer whose loss is limited to the option premium paid.

    SEBI allows MFs to enter into plain vanilla interest rate swaps for hedging purpose but now SEBI has specified that the counter party to such a transaction has to be a RBI recognised market-maker. Also, exposure to single counterparty cannot now exceed 10 per cent of the net asset of the scheme.

    Each position taken in derivatives shall have an associated exposure as given in the table. Exposure is the maximum possible loss that may occur on a position. However, certain derivative positions may theoretically have unlimited possible loss.

    Position

    Exposure

    Long Future

    Futures Price * Lot Size * Number of Contracts

    Short Future

    Futures Price * Lot Size * Number of Contracts

    Option bought

    Option Premium Paid * Lot Size * Number of Contracts



    SEBI has in its circular specified the format for mutual funds to disclose their derivatives holdings in their half-yearly report. This had not been specified in the past and as a result the disclosures across the industry have not been uniform.

    The Impact: Mutual funds are no longer exposed to the unlimited risk that trading in options entails. Apart from the ban on selling options, limits have been imposed on exposure to other derivatives positions, effectively capping risks to fund portfolios. The regulatory move was prompted by sudden spurt derivatives trading volumes of mutual funds in June 2010.

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