Indian regulator tightens derivatives rules

Sebi has banned mutual funds from writing options and placed prudential limits on the amount of derivatives investments that can be made by mutual funds in the country in a bid to tighten regulation


The Securities and Exchange Board of India (Sebi) has banned the use of some equity derivatives by mutual funds, including barring them from writing options contracts. The new rules are applicable for all new schemes launched from August 18, whereas for all existing schemes, they become effective from October 1, according to the regulator.

‘'Mutual funds shall not write options or purchase instruments with embedded written options,'' Sebi stated in a circular issued to the market. It also limited the premium paid for option purchases. ‘'The total exposure related to option premium paid must not exceed 20% of the net assets of the scheme," Sebi said.

However, mutual funds can hedge their positions using a combination of cash and derivatives, including using interest rate swaps. "Cash or cash equivalents with residual maturity of less than 91 days may be treated as not creating any exposure,' Sebi said, adding: "Mutual funds may enter into plain vanilla interest rate swaps for hedging purposes. The counterparty in such transactions has to be an entity recognised aas  market maker by [the] Reserve Bank of India (RBI)."

Moreover, Sebi's updated regulation allows mutual funds to enter into plain vanilla interest rate swaps for hedging purposes, as long as the counterparty in such transactions is an entity recognised as a market maker by the RBI. "Further, the value of the notional principal in such cases must not exceed the value of respective existing assets being hedged by the scheme," the regulator added. "Exposure to a single counterparty in such transactions should not exceed 10% of the net assets of the scheme." 

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