Norms for investment by mutual funds in derivatives and related disclosures

SEBI vide circular Cir/ IMD/ DF/ 11/ 2010 dated August 18, 2010 has made the following modifications to the rules in relation to the investments by mutual funds in derivatives:

• Regulation 59 of the SEBI (Mutual Funds) Regulations, 1996 (“Regulations”) states that all mutual fund companies should publish half yearly results and it should contain the details as specified in twelfth schedule of the Regulations. As per the twelfth schedule, mutual funds should disclose, any exposure in derivative products for more than 10 per cent of the net assets of any scheme. However, the Regulations did not prescribe a format for this disclosure and as such and the disclosures being made by various mutual funds were not uniform across the industry. Now SEBI, vide this new circular, has prescribed the format and other details for such disclosure. SEBI has also defined the expression ‘exposure in derivatives’ and has also prescribed a manner for computation of the same. 
• The cumulative gross exposure through equity, debt and derivative positions should not exceed 100% of the net assets of the scheme.
• Mutual Funds cannot write options or purchase instruments with embedded written options (derivative instrument against another derivative).
• The total exposure related to option premium paid should be limited to 20% of the net assets of the scheme.
• However mutual funds can enter into plain vanilla interest rate swaps for hedging purposes. The counter party in such transactions has to be an entity recognized as a market maker by RBI. 

The rules will be effective from October 1, 2010 for all new schemes as well as the existing schemes.

A copy of the circular is available here.