SEBI allows Mutual Fund Participation to trade Commodity Derivatives

On 21^st May, 2019, the Securities and Exchange Board of India (SEBI) permit mutual funds to participate in exchange-traded commodity derivatives (ETCD) on behalf of their clients to promote institutional participation in the segment. Hence, SEBI has allowed Category III Alternative Investment Funds to participate in exchange-traded commodity derivatives.

What are Exchange Traded Commodity Derivatives?

An exchange-traded commodity (ETC) gives traders and investors exposure to commodities (called the underlying) in the form of shares. Traded like a stock, i.e., bought and sold on a stock exchange, ETCs track the price movement of commodities like oil, gold, and silver and then fluctuate in value based on those commodities. ETCs may track individual commodities and/or a commodity basket.

Mutual Funds participation in Exchange Traded Commodities Derivatives (ETCDs)

In the recent notification, portfolio managers will be able to participate in Exchange Traded Commodity Derivatives agreeing with the client. For the existing clients, they may execute addendums to the agreement which will allow them to participate in ETCDs on SEBI’s behalf.

Moreover, it would be compulsory for portfolio managers to appoint SEBI registered custodian before dealing in ETCDs

• As per the latest guidelines, SEBI has allowed mutual funds to participate in all the exchange-traded Commodities Derivatives except the “Sensitive Commodities.”
• Until now, Mutual Funds were not permitted to invest in the commodities other than gold.

Effect of Mutual Funds participation in Exchange Traded Commodities Derivatives (ETCDs)

• Commodity derivatives are an unbalanced space on a standalone basis. Hence, mutual funds will make a decision to initiate commodity-dedicated schemes.
• Commodity derivatives can be a part of hybrid schemes that will give diversification flavor across equities commodities and debt.

However, physical delivery is not allowed, which could be a hindrance for MFs going for commodity funds.

Guidelines introduced by SEBI

• SEBI has now allowed mutual funds to contribute in all exchange-traded commodities derivatives (ETCDs) except the ‘sensitive commodities’.

“Please note that Essential commodities in the Agri segment are considered as sensitive.”

• Hybrid and gold exchange-traded funds are allowed to participate in ETCDs. However, they have been banned from taking physical delivery.
• Also, it was informed that no mutual fund scheme shall have net short positions in ETCD on any particular good because of its locations in physical products as well as ETCDs at any time.
• SEBI has bound fund houses to appoint a dedicated fund manager with necessary skills and experience in the commodities market (including commodity derivatives market) before trading in ETCDs
• Moreover, SEBI directed Mutual Funds to appoint a custodian registered with it for custody of the underlying goods which arises due to physical settlement of the contracts.

Hedging

• MFs can now hedge with commodities derivatives against metals, oil and gas and other commoditized equities.
• Investment in exchange commodity derivatives will regularly add value from an inflation hedging opinion.

The Viewpoint of Asset Manager on Commodity Derivatives

• As per various asset managers, commodity derivatives can be used as a hedge against equity market oil price shocks.
• In the case of a slowdown in metals or utilities, commodity derivatives can act as a hedge in hybrid portfolios.

Commodity Exposure

• SEBI has now started working toward developing the commodities market by bringing in more products and participants like FPIs, insurance, and mutual funds.
• Earlier, SEBI was concerned about the low participation of producers and hedgers in the commodity market.

After 2017, SEBI designed various rules to change commodity market to introduce transparency, reduce risks and include new participants such as banks, mutual funds, foreign portfolio investors (FPIs) and alternative investment funds, to improve liquidity.

This move will give retail investors indirect exposure to the commodities market for the first time.

Conclusion

This is a welcome step for the Indian Commodity Market. SEBI has address many concerns that asset managers will have. But, categorizing mutual funds as ‘Clients’ and subjecting them to participation limits are significant concerns. If mutual funds can find the right fund manager with an investment, then it would encourage investors to participate in this asset class.

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