Sebi proposes to allow MFs and portfolio managers in commodity derivatives

Market regulator Securities and Exchange Board of India (Sebi) has proposed to permit Mutual Funds (MFs) and portfolio managers (PMs) to participate in the exchange-traded commodity derivatives market. Sebi on Thursday issued a consultation paper seeking public views on this proposal, besides how they should be allowed and what regulatory framerwork should be put in place for this.

This is the second move by Sebi to allow institutional participants in commodity derivatives. Earlier, the regulator had allowed category-3 alternative investment funds or hedge funds. The latest proposal of allowing MFs and PMs will be the second in the direction of broad-basing the commodity derivatives segment to improve liquidity and include institutional players. However, the consultation paper did not specify whether or not MFs and PMs would be allowed in agriculture commodity derivatives but it did mention commodity derivatives as an asset class.

Portfolio managers had earlier been active in commodity derivatives, but the erstwhile commodity regulator, the Forward Markets Commission, had banned their play in the segment.

Thursday’s consultation paper inviting public comments till the end of this month, has explained several commodities, their indices and their correlation with their respective spot markets.However, the table containing the information doesn’t mention any agricultural commodity which gives an impression that this new class of investors will not be permitted in agri commodities.

Industry officials argue that institutional players shall be allowed in agri commodities, too. One of them who did not wish to be named said: “There are enough safeguards through poison limits, etc, to prevent too much money flowing into agri commodities. At the same time, the agri market needs the sophistication of institutional players to bring more research-based participation.” Information from brokers says that several companies have also started hedging their commodity risk in liquid agri commodities, so there is a need to allow the new category of institutional investors in commodity derivatives.

As of now, only gold is the permitted commodity for institutional investors who can participate through exchange-traded funds (ETF). Seven years ago, the National Stock Exchange (NSE) had permitted silver ETF but the permission was later withdrawn. One big ETF had also proposed crude oil ETF, but the permission never came.

Sebi has said that its Commodity Derivatives Advisory Committee (CDAC) has suggested that the commodity derivatives market should be opened up for institutional participation i.e. both domestic and international, in a phased manner. The regulator, while recognising commodity derivatives as a new asset class, also warned that adding commodities in the portfolio would typically increase some risk, but the overall risk-adjusted return of the portfolio might improve.

Addition of commodities to a hybrid portfolio can lower the overall volatility of the portfolio, since returns from commodities have historically not been highly correlated with returns from equities and fixed-income asset classes.

Sebi has proposed three options for allowing MFs in the commodity segment — ETFs based on commodity derivatives, open-ended schemes (passive/active) based on commodity derivatives, and commodity arbitrage funds — and sought views on what else could be done. Sebi also sought to know whether there should be any investment restrictions for them in commodities, could this be part of their present assets under management (AUMs) or come through separate schemes.