Sebi proposes to allow MFs and portfolio managers in commodity derivatives

This is the second move by Sebi to allow institutional participants in the commodity derivatives market

The Securities and Exchange Board of India (Sebi) proposes to permit mutual funds (MFs) and portfolio managers (PMs) to participate in exchange-traded commodity derivatives. 

On Thursday, it issued a consultation paper on this, seeking reactions by the end of this month — on allowing them, how and a possible regulatory framework. 

This is the market regulator's second move to allow institutional participants in commodity derivatives. Earlier, it had decided to allow category-III alternative investment funds or hedge funds. Allowing MFs and PMs would be a second move in the direction of broadbasing the commodity derivative segment, to improve liquidity and permit institutional players.

PMs were active in commodity derivatives till the erstwhile segment regulator, the Forward Markets Commission, decided to ban them. The new consultation paper has explained several commodities and their indices and their correlation with the respective spot market. However, the table containing the information doesn’t mention any agricultural commodities, giving the impression that this class of investors will not be permitted here.

However, sector officials say institutional players should also be allowed in agri commodities. Samir Shah, managing director at the National Commodity and Derivatives Exchange, said: “There are enough safeguards through position limits, etc, to prevent too much money flowing into agri. At the same time, the agri markets need the sophistication of institutional participation to bring more research-based participation.” According to brokers, several companies have also started hedging their commodity risk in liquid agri commodities. Hence, there is a need to allow the new category of institutional investors in commodity derivatives."

As of now, only gold is a permissible commodity for institutional investors and are allowed through exchange-traded funds (ETFs). Around seven years earlier, the National Stock Exchange had permitted a silver ETF but this was later withdrawn. An ETF in crude oil was also proposed, but it was never permitted. 

The exchanges have been discussing the issue with MFs and PMs. Some MFs have been preparing for the day when Sebi allows them into commodities. A Multi Commodity Exchange spokesperson said, “Sebi’s proposal shows its commitment to developing the commodity derivatives market and emphasises the importance of institutional participation. With MFs witnessing huge inflow, indicating increased participation from a larger base of investors, the commodities segment being available to fund and portfolio managers as an additional or alternative asset class for diversification assumes significance.” 

Adding: “We have been in continuous engagement with the MF and PMS industry, alongside Sebi, and expect the industry will also take all initiatives to be ready for participation, as soon as guidelines are issued.”

Sebi has said its Commodity Derivatives Advisory Committee (CDAC) has recommended the market here be opened to institutional participation, domestic and international, in a phased manner. Recognising commodity derivatives as a new asset class, it noted, “Adding commodities in the portfolio would typically increase some risk but the overall risk-adjusted return on the portfolio might improve. Addition of commodities to a hybrid portfolio could lower the overall volatility, as returns from commodities have not been highly correlated with returns from equities and fixed income asset classes.”

Sebi has proposed three ways of allowing MFs in the commodity segment. One, ETFs based on commodity derivatives. Two, open-end schemes (passive/active) based on commodity derivatives. Three, commodity arbitrage funds. It has sought views on what else could be done. 

It also sought to know whether there should be any investment restrictions in commodities and if this be part of existing assets under management or through separate schemes. 

For portfolio managers, whether PMs could be permitted to leverage the portfolio of their clients for investing in commodity derivatives and the level of leverage they should be allowed. Apart from whether this investment can be done by pooling money from investors.

Decoding the proposal

• Sebi may not allow MFs and PMs in agri segment
• Recognises commodity derivatives as an asset class
• New proposal emphasises need for institutional participants
• Portfolio managers were banned a few years ago by FMC from commodity derivatives
• Sebi wants to know what should be investment limits for MFs and leverage limits for PMs