Commodity hedge funds see low position limits, tax as hurdles

Last week, Sebi allowed few Category III AIFs or hedge funds, to invest in commodity derivates

Hedge funds in commodity derivatives may begin business cautiously, exactly the way the regulator intended it.
 
A few category-3 alternative investment funds(AIFs) were last week allowed by the Securities and Exchange Board of India(SE to invest in commodity derivatives. Most of them will approach existing investors for permission to invest in commodity derivatives. The reason for the AIFs’ caution is they have been treated as clients and client-level position limits will apply to them. Thus, they cannot take more than a 10 per cent position in any commodity.
 
A source said there were a handful of commodities like edible oils, cotton, energy and precious metals where the liquidity in derivatives was adequate to attract AIFs. Another limiting factor is tax, which is considered high for hedge funds. “If the regulator wants to develop the Indian hedge fund industry, taxation should be more reasonable. There is no level playing field,” a source said. China’s hedge fund industry has grown to $400 billion because the tax treatment is conducive. AIFs or venture/private equity funds interested in this segment have started studying the feasibility of the business.

 

Rajat Tandon, president, Indian Private Equity and Venture Capital Association (IVCA), said, “We are jointly working with Multi-Commodity Exchange (MCX) for AIFs. Commodity derivatives will open a new avenue for AIFs and expand the investor base available for capital raising.” He said the IVCA would meet the Murthy committee to discuss investments by AIFs in commodity derivatives. Sebi had constituted the Alternative Investment Policy Advisory Committee (AIPAC) under the chairmanship of Infosys co-founder N R Narayana Murthy in March 2015.
 
“Sebi took a progressive step by allowing Category III AIFs in commodities. With their entry, the market will have institutional investors that can provide liquidity, take different side positions and use spare cash for investing in commodities. Agri-commodities will get a boost as these funds can take deliveries when they make contra-calls,” said C P Krishnan, director, Geofin Comtrade.

 
Industry veterans agree the preferred strategy for such funds will be to approach existing investors for consent to invest in commodity derivatives. Separate funds will come about when the position limits are wide enough to make their business viable.

Investing in derivatives

• Sebi last week issued a circular to permit category-3 alternative investment funds, also known as hedge funds, in commodity derivatives.
   
• These funds will invest in futures as well as options, including selling options.
   
• Initially, they may invest from existing funds after obtaining the consent of existing investors.
   
• The fund industry body has set up a council to deliberate the issues and will meet Sebi next week to discuss them.