Oversight February 2019 - SFC issues Guide on the Use of Financial Derivative Instruments for Unit Trusts and Mutual Funds

Introduction

On 17 December 2018, the Securities and Futures Commission (SFC) published the Guide on the Use of Financial Derivative Instruments for Unit Trusts and Mutual Funds (Derivative Guide).

The purpose of the Derivative Guide is to provide guidance to management companies of SFC-authorised schemes on the use of financial derivative instruments (derivatives) so as to comply with the relevant requirements under the revised Code on Unit Trusts and Mutual Funds (UT Code). The new UT Code came into effect of 01 January 2019 (although there is a transitional period of 12 months provided to existing scheme and existing scheme operators).

Chapters 7 and 8 of the UT Code set out the limits on net exposure arising from the use of derivatives (net derivative exposure) for different types of SFC-authorised schemes. The net derivative exposure of a scheme authorised under Chapter 7 of the UT Code may not exceed 50% of its total net asset value (NAV). A passively managed index tracking fund (including unlisted index funds, index tracking exchange traded funds (ETFs) and leveraged and inverse products (L&I Products)) with a net derivative exposure level of over 50% of its NAV will be regarded as a structured fund and must comply with the requirements under Chapter 8.8 of the UT Code. An actively managed scheme with a net derivative exposure level of over 50% of its NAV must comply with the provisions under Chapter 8.9 of the UT Code which (among other requirements) imposes a 100% limit on the net derivative exposure of such scheme.

Under the new UT Code and the Derivative Guide, a manager of SFC-authorised funds (including UCITS funds, ETFs and L&I Products) is expected to disclose the expected maximum net derivative exposure as a proportion to each scheme’s NAV in the scheme’s offering documents. Fund managers should note that, for UCITS funds, this disclosure requirement is in addition to any existing disclosure requirements in relation to the use of derivatives under the UCITS regime.

In connection with these revised UT Code requirements regarding the use of derivatives, the Derivative Guide provides guidance on the calculation of net derivative exposure and illustrative examples for fund managers’ reference.

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