Trading by Mutual Funds in Exchange Traded Derivative Contracts - SEBI - DNPD/Cir-29/2005

M. S. SAHOO CHIEF GENERAL MANAGER DNPD/Cir-29/2005 September 14, 2005 To 1. The Managing Director NSE, BSE and their Clearing House / Corporation 2. All Mutual Funds registered with SEBI 3. Association of Mutual Funds in India. Dear Sir, Sub: Trading by Mutual Funds in Exchange Traded Derivative Contracts 1. At present Mutual Funds are permitted to participate in the derivatives market for the purpose of hedging and rebalancing their portfolio in accordance with the SEBI Circular no. MFD/CIR/21/25467/2002 dated on December 31, 2002. This restriction on the participation of Mutual Funds in the derivatives market followed from the recommendations of the Committee on Derivatives chaired by Dr. L. C. Gupta. Since then there have been several changes in the structure of the cash market and the volumes in the derivatives market have increased manifold. It is also observed that there has been a significant increase in retail participation in the derivatives market. 2. Following the recommendations of the Secondary Market Advisory Committee, based on the above considerations, it has been decided to permit the Mutual Funds to participate in the derivatives market at par with Foreign Institutional Investors (FII). Accordingly, the Mutual Funds shall be treated at par with a registered FII in respect of position limits in index futures, index options, stock options and stock futures contracts. The Mutual Funds will be considered as trading members like registered FIIs and the schemes of Mutual Funds will be treated as clients like sub-accounts of FIIs. I) Applicability a. This revised policy shall be applicable to all new schemes which are yet to be launched, or for which offer documents have been submitted to SEBI for approval. Appropriate disclosures shall be made in the offer document regarding the extent and manner of participation of the schemes of the Mutual Funds in derivatives and the risk factors, which should be explained by suitable numerical examples. b. The participation of existing schemes of the Mutual Funds in the derivatives market shall be subject to the following conditions: 1. The extent and the manner of the proposed participation in derivatives shall be disclosed to the unit holders. 2. The risks associated with such participation shall be disclosed and explained by suitable numerical examples. 3. Positive consent shall be obtained from majority of the unit holders. 4. An exit option shall be provided to the dissenting unit holders. Such option shall be kept open for a period of one month prior to the scheme commencing trading in derivatives. 5. No exit load shall be charged to the unit holders exercising such exit options. II) Position Limits The position limits for Mutual Funds and its schemes shall be as under: i. Position limit for Mutual Funds in index options contracts a. The Mutual Fund position limit in all index options contracts on a particular underlying index shall be ₹ 250 crore or 15% of the total open interest of the market in index options, whichever is higher, per Stock Exchange. b. This limit would be applicable on open positions in all options contracts on a particular underlying index. ii. Position limit for Mutual Funds in index futures contracts : a. The Mutual Fund position limit in all index futures contracts on a particular underlying index shall be ₹ 250 crore or 15% of the total open interest of the market in index futures, whichever is higher, per Stock Exchange. b. This limit would be applicable on open positions in all futures contracts on a particular underlying index. iii. Additional position limit for hedging In addition to the position limits at point (i) and (ii) above, Mutual Funds may take exposure in equity index derivatives subject to the following limits: 1. Short positions in index derivatives (short futures, short calls and long puts) shall not exceed (in notional value) the Mutual Fund s holding of stocks. 2. Long positions in index derivatives (long futures, long calls and short puts) shall not exceed (in notional value) the Mutual Fund s holding of cash, government securities, T-Bills and similar instruments. iv. Position limit for Mutual Funds for stock based derivative contracts The Mutual Fund position limit in a derivative contract on a particular underlying stock, i.e. stock option contracts and stock futures contracts, stand modified in the following manner:- 1. For stocks in which the market wide position limit is less than or equal to ₹ 250 crore, the Mutual Fund position limit in such stock shall be 20% of the market wide position limit. 2. For stocks in which the market wide position limit is greater than ₹ 250 crore, the Mutual Fund position limit in such stock shall be ₹ 50 crore. v. Position limit for each scheme of a Mutual Fund The position limits for each scheme of mutual fund and disclosure requirements shall be identical to that prescribed for a sub-account of a FII. Therefore, the scheme-wise position limit / disclosure requirements shall be 1. For stock option and stock futures contracts, the gross open position across all derivative contracts on a particular underlying stock of a scheme of a mutual fund shall not exceed the higher of: 1% of the free float market capitalisation (in terms of number of shares). Or 5% of the open interest in the derivative contracts on a particular underlying stock (in terms of number of contracts). 2. This position limits shall be applicable on the combined position in all derivative contracts on an underlying stock at a Stock Exchange. 3. For index based contracts, Mutual Funds shall disclose the total open interest held by its scheme or all schemes put together in a particular underlying index, if such open interest equals to or exceeds 15% of the open interest of all derivative contracts on that underlying index. III) Monitoring of Position Limits a. The Mutual Fund shall notify the names of the Clearing Member/s for each scheme through whom it would clear its derivative contracts to the Stock Exchange. b. The Stock Exchange would then assign a unique client code to each scheme of the Mutual Fund. c. The Stock Exchange shall monitor the scheme-wise position limits in the manner similar to that prescribed for FIIs and their sub-accounts in SEBI circular no. SMD/DC/Cir-11/02 dated February 12, 2002 as modified from time to time. 3. This circular is in supersession of the previous circulars no. MFD/CIR/011/061/2000 dated February 1, 2000, no. MFD/CIR/21/25467/2002 dated December 31, 2002 and no. SEBI/IMD/Cir No. 4/2627/2004 dated February 6, 2004 issued to Mutual Funds registered with SEBI. 4. This circular is being issued in exercise of powers conferred by section 11 (1) of the Securities and Exchange Board of India Act, 1992, read with section 10 of the Securities Contract (Regulation) Act, 1956, to protect the interests of investors in securities and to promote the development of, and to regulate the securities market. Yours sincerely, (M. S. SAHOO)