February 1, 2000
All Mutual Funds registered with SEBI/
Unit Trust of India
Re. : Guidelines for Participation by Mutual Funds in Trading in Derivative Products
According to recently amended Regulation 45 of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, mutual funds can enter into derivative transactions for the purpose of hedging and portfolio balancing in accordance with Guidelines issued by SEBI.
We are enclosing detailed guidelines in this regard, which are being issued in accordance with the provisions of Regulation 77.
Encl : as above
Guidelines for participation by Mutual Funds in trading in Derivative Products
The Mutual Funds shall be required to adhere to the following guidelines for trading in derivatives:
1. Purpose of investment:
i. Trading in derivatives by mutual funds shall be restricted to hedging and portfolio balancing purposes.
ii. The mutual funds shall be required to fully cover their positions in the derivatives market by holding underlying securities ! cash or cash equivalents ! option and ! or obligation for acquiring underlying assets to honour the obligations contracted in the derivatives market.
iii. Separate records shall be maintained for holding the cash and cash equivalents ! securities for this purpose.
iv. The securities held shall be marked to market by the AMC to ensure full coverage of investments made in derivative products at all time.
1. Disclosure requirements: The following disclosure requirements shall be mandatory for mutual fund schemes proposing to invest in derivative products:
i. The intention to trade in derivative products shall be disclosed in the offer documents.
ii. The risks and returns ensuing from trading in derivatives shall be explained by means of a simple quantitative example.
iii. The appropriate risk factors attendant upon such investments shall be disclosed in a comprehensible and simple manner.
iv. The offer document of a scheme envisaging derivative trading shall state unambiguously and clearly the losses that may be suffered by the investors as a consequence of such investments.
v. The mutual funds shall disclose as to how trading in derivatives will help in the furtherance of the investment objectives of the scheme.
vi. The mutual funds shall lay down exposure-limits for themselves and disclose the same in the scheme offer-document.
1. Valuation : Regarding valuation of derivative products:
i. The traded derivatives shall be valued at market price in conformity with the stipulations of sub clauses (i) to (v) of clause 1 of the Eighth Schedule to the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996.
ii. The valuation of untraded derivatives shall be done in accordance with the valuation method for untraded investments prescribed in sub clauses (i) and (ii) of clause 2 of the Eighth Schedule to the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996.
1. Reporting requirements: The AMC shall cover the following aspects in their reports to trustees periodically, as provided for in the Regulations:
i. Transactions in derivatives, both in volume and value terms.
ii. Market value of cash or cash equivalents ! securities held to cover the exposure.
iii. Any breach of the exposure limit laid down in the scheme offer document.
iv. Short-fall, if any, in the assets covering investment in derivative products and the manner of bridging it.
v. The Trustees shall offer their comments on the above aspects in the report filed with SEBI under sub regulation (23) (a) of regulation 18 of Securities and Exchange Board of India (Mutual Funds) Regulations, 1996.
1. Existing schemes: In case the offer document of an existing scheme does not provide for trading in derivatives, the scheme, if it so desires, may trade in derivatives in accordance with these guidelines, provided that:
i. It obtains approval from the trustees.
ii. Trustees shall take reasonable steps to ensure that the asset management company possesses adequate expertise and infrastructure for derivative trading.
iii.It informs the unit-holders of its intention to trade in derivatives and making all disclosures as mentioned earlier in the guidelines.