The Securities and Exchange Board of India (Sebi) has proposed allowing mutual funds and portfolio management services (PMS) firms to invest in commodity derivatives.
In a discussion paper issued on Thursday, the capital markets regulator has also sought comments on whether a commodity-specific exchange traded fund (ETF) can be launched. Mint had reported this first on 10 November.
The proposal comes on the back of recommendations of the Commodity Derivatives Advisory Committee, which had proposed institutional participation to increase liquidity in commodity derivatives. These are new institutional investor categories in this segment. On 26 April, the market regulator had allowed category-III alternative investment funds (AIFs), which include hedge funds, to invest in commodity derivatives.
“Adding commodities in the portfolio would typically increase some risk, but the overall risk adjusted return of the portfolio may improve,” Sebi said in the discussion paper.
“The proposal to permit mutual funds and portfolio managers to invest in commodity derivatives is a welcome development and in line with the series of liberalization measures notified over the past couple of years to provide more asset classes to investors and increase participation of domestic institutions,” said Tejesh Chitlangi, a partner at IC Universal Legal. “Since it’s a riskier asset class, adequate checks and balances will have to be put in place before implementation and which may have to be more stringent compared to the norms which have recently been prescribed for category-III AIFs.”
Sebi is also looking at mutual funds and PMS as a way for retail investors to get exposure to commodity derivatives while minimizing volatility risk. “A substantial number of investors (including retail investors) are not able to directly access the commodity derivatives market due to lack of knowledge and expertise. MFs and PMS can act as conduits to commodities markets for such investors,” Sebi said in the discussion paper. It is also considering an open-ended fund-of-fund with an underlying commodity ETF, such as a gold fund-of-fund and a commodity arbitrage fund.
For PMS, Sebi has proposed that commodity derivatives should be used for leveraging and investments should be pooled to avoid concentration risk. “Pooling of investments may be permitted in respect of transactions in exchange-traded commodity derivatives, which is presently not permitted,” said Sebi in the circular.
One key area Sebi will have to amend before allowing mutual funds and PMS is custodian regulations. “Sebi custodian regulations do not make it clear whether they can provide services for commodities,” said Rajini Panicker, head of research, commodities, at PhillipCapital.
Custodians are clearing members and they settle trades on behalf of their clients that are executed through other trading members. AIFs, mutual funds and foreign portfolio investors need to invest via custodians.