Published On: Thu, Aug 19th, 2010

SEBI Bars Use of Equity Derivatives by Mutual Funds

Capital market regulator the Securities and Exchange Board of India (Sebi) has curbed the use of equity derivatives by mutual funds, including barring them from selling options contracts. The securities market regulator, in a circular released Wednesday, announced that ban would be effective October 1, without specifying the reason.

The move to bar mutual funds from selling options, according to asset management industry officials, could be that the market regulator is worried about the impact of selling illiquid options. Options sellers face the risk of unlimited losses, unlike buyers, who lose only the premium, if bets go wrong.

A top mutual fund official termed the ban as ‘harsh’, as most mutual funds are not big sellers of options. “Funds, which sell options, restrict them to a minuscule portion of the portfolio. The options writing is mostly against delivery. There shouldn’t have been a blanket ban,” the official said.

Sebi had sought mutual funds’ feedback on the proposal in May, when the industry had suggested restrictions on options selling rather than a complete ban. Brokers said that the impact of the ban on options market volumes would not be significant, as fewer mutual funds are big options sellers.

The market regulator said that the cumulative gross exposure to equity, debt and equity derivatives should not exceed 100% of the net asset value of the scheme. Mutual fund officials said the move is to restrict their exposure to hedging stock positions. Sebi added that the total exposure to options premium should not exceed 20% of the net asset of a scheme.

The regulator has allowed 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 RBI. Further, 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% of the net assets of the scheme,” it said.

Sebi, in the circular, specified the format for mutual funds to disclose their derivatives holdings in their half-yearly report. This has not been specified in the past and the disclosures across the industry have not been uniform, it said.

“While listing net assets, the margin amounts paid should be reported separately under cash or bank balances,” Sebi said.

Source: The Economic Times

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