ClassroomCorner: New participants in commodity derivatives

The commodities derivatives market in India, at present, lacks liquidity and does not help participants in effective price risk management. In order to overcome this and make it a good platform for hedgers and traders, SEBI (the Securities and Exchange Board of India) allowed participation of category III AIFs (Alternative Investment Funds) in the commodities derivatives segment, last week. At present, institutional participants are not allowed in the commodity derivatives market.

What is AIF?

AIF are privately pooled investments from either Indians or foreigners. Those institutions that need permission from SEBI to operate as AIFs and get incorporated in India can take registration in category I, II or III.

What is category III AIFs?

Category III are those AIFs that invest in different asset classes and use diverse strategies to leverage by trading in listed or unlisted derivatives. This category includes hedge funds and PIPE funds (Private Investment in Public Equity). Category I includes venture capital funds and SME funds and category II includes funds that do not undertake leveraging or borrowing other than to meet-day-to-day operational requirements. The participation of Category III AIF in commodity derivatives market shall be in compliance with the provision of SEBI (Alternative Investment Funds) Regulations 2012.

AIFs in commodity derivatives

Based on the recommendations of CDAC (Commodity Derivatives Advisory Committee) and other market participants, SEBI has allowed Category III AIFs to invest in commodity derivatives. But it has some conditions. One, AIFs shall not invest more than 10 per cent of investable funds in one underlying commodity and, two, they shall be subject to all the regulations and instructions as applicable to clients in the commodity market issued by SEBI and exchanges from time to time.

Further, AIFs will have position limits as applicable to the clients and will be subject to the reporting requirements specified by SEBI.

The move, overall, is considered positive as participation of institutional investors will improve and give liquidity to participants. It will bring more hedgers and become an effective place for price discovery.

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