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MFs' initial response to new commodity derivatives norms likely to be muted

Long-term liquidity may not improve in current framework

sebi
Rajesh Bhayani Mumbai
4 min read Last Updated : May 22 2019 | 11:51 PM IST
Sebi’s new norms allowing mutual funds to participate in the commodity derivatives segment will not help improve medium- to long-term liquidity in the market. In commodity futures, only current and, to an extent, next month contracts have liquidity and that too just a handful of them.

Commodity market or exchanges are still waiting to see real liquidity and depth in the market, which institutional investors like Mutual Funds can provide. However, several riders enforced due to the finance ministry's over-cautious approach seem to be straining the market.

After Sebi approved regulations for MFs' participation in commodity derivatives, the finance ministry expressed certain reservations on whether funds with strong financial muscles will pull prices up. To address the concern, Sebi did not allow funds to take physical deliveries. 

A fund manager who did not want to be named said that had physical deliveries been allowed, they would have preferred to buy very far-month contracts. This would have let them keep money in an escrow account, but the actual payment could have been made when they took a delivery. Consequently, they would have had the chance to book a profit mid-way.

Nevertheless, there are some positives for funds. For instance, they can accommodate commodities as a part of their existing schemes. Hedge funds have been allowed to participate, but have to float new schemes and the maximum exposure to one commodity has been fixed at 10 per cent. What this means is that they have to invest in at least 10 commodities to meet this norm. The trouble is that they cannot identify 10 commodities that are liquid enough to make the business lucrative for them and hence, aren't able to do much.


Another fund house executive said his outfit may remain muted to the segment: “We will have to beef up our commodities team, approach our board with a policy on the issue, then give time to investors of existing schemes in which we have to add commodities derivatives and allow them exits if they are not interested. All these will take time.”

Under Sebi's framework proposed on Tuesday, MFs have limited scope to form strategies. Initially, they can avail some arbitrage opportunities and participiate in trading or hedging in sync with equity investments. For example, they can go long in base metals and stay put in them. But, that will not add significant value for investors or for commodity exchanges till the market picks up.

Gold ETFs

Sebi also outlined a few important changes in gold exchange-traded fund (ETF) regulations. Allowing them to enter gold derivatives would help them buy at lower-than-market rates whenever futures prices are quoted below the physical market. In recent months, that was happening frequently and many traders were seen selling in the physical market and buying futures. Only gold ETFs have been allowed to take physical deliveries.

The second and most important change is for gold ETFs is that Sebi has allowed them to invest the metal through the Gold Monetising Scheme and the Gold Deposit Scheme. Earlier, RBI had allowed ETFs to park gold in GMS, but as ETFs are regulated by the Sebi, it will be operational now onwards. The real issue is GMS itself is not operational in a practical sense.

The Gold Deposit Scheme has not been announced yet. Currently, ETFs don’t earn on the gold they buy for investors. The deposit scheme will earn them some returns. But they have been allowed, under RBI norms, to cap returns at not more than 20 per cent and they have to manage redemption pressure whenever that happens as GMS is for fixed tenures.

Experts suggest that ETFs should be allowed to lend the gold they hold to jewellers through banks.
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