After a long wait, Sebi notifies rules for MFs to enter commodity space

Fund houses have been barred from being net sellers or holding net short positions at the scheme level in commodities

Market regulator Sebi has permitted mutual funds to participate in all exchange-traded commodities except the ‘Sensitive Commodities’. Essential commodities in the agri segment are regarded as sensitive. Along with MFs, gold exchange-traded funds also have been allowed to participate, but only in gold derivatives.

After a year-long debate, the Securities and Exchange Board of India has finally issued a circular allowing funds to enter the commodity derivatives space. However, they have been barred from taking physical delivery.

Even if they have to take physical deliveries as a part of settlement, they will have to dispose the goods within 30 days and also appoint a custodian to handle physical stocks. This had been a contentious issue, because custodians were not prepared to handle physical deliveries of commodities even though MFs have to operate through them.

Another major condition the regulator has made is that the scheme investing in commodities shall not have foreign portfolio investments till such time as foreign investors are allowed in commodities.

So far, Sebi has allowed Category-3 alternative investment funds, or hedge funds, and Eligible Foreign Entities (EFE) having actual exposure to Indian commodity markets, to participate in commodity derivatives. Foreign Portfolio Investors are still not allowed in this space.

Interestingly gold ETFs have also been allowed to participate in Gold Deposit Schemes and Gold Monetisation Scheme. GMS is operative but GDS is expected to be announced in future. This permission to them was given by the RBI under a relevant notification for GMS, but for the first time, Sebi has cleared the way for gold ETFs by amending the respective circular.

Investment in commodities without physical delivery is defined vide Sebi circular no. SEBI/HO/CDMRD/DMP/CIR/P/2017/84 dated July 25, 2017. In partial modification to paragraph 3 of Sebi Circular No. CIR/IMD/DF/11/2015 dated December 31, 2015, it has been decided that ETCDs having gold as the underlying asset, shall also be considered as ‘gold related instruments’ for Gold Exchange Traded Funds (Gold ETFs).

No mutual fund schemes shall invest in physical goods except in ‘gold’ through Gold ETFs. Further, as mutual fund schemes participating in ETCDs may hold the underlying goods, in case of physical settlement of contracts, mutual funds shall dispose of such goods from the books of the scheme at the earliest, not exceeding 30 days from the date of holding the physical goods.

Mutual fund have been barred from becoming net sellers or holding net short positions at the scheme level in commodities and for this they have to take into account their positions in physical goods.

To allow funds to participate early, they are permitted to enter commodities through hybrid schemes, which include multi-asset schemes and Gold ETFs. MFs have represented that only commodity-dedicated schemes will not help if they have to abide by the 10 per cent commodities specific cap, as there are hardly 10 such commodities which are very liquid, considering the non-sensitive nature of farm commodities.

In case of existing schemes deciding to participate in commodities, Sebi has asked funds to give all unit holders a time period of at least 30 days to exercise the option to exit at prevailing NAVs without charging any exit load.

Game of Trades

• Funds not allowed to take physical delivery, hold net short positions 
• Existing schemes — hybrid or multi-assets — also permitted
• Gold ETFs given nod to participate in derivatives of gold and GMS 
• Scheme investment will attract client-level position limits 
• At MF level, ‘trading member’ position limit will apply
• For multi-asset schemes, 30% limit for commodities; for other hybrids, 10 per cent exposure limit prescribed