New Delhi: Regulator Sebi on Friday proposed allowing hedge funds to participate in commodity derivatives, in a move to deepen the market and step up liquidity.

However, this is subject to certain conditions, including that category III alternative investment funds (AIFs) or hedge funds should not invest more than 10% of the investable funds in one underlying commodity.

Besides, they should make disclosure in private placement memorandum issued to investors about investment in commodity derivatives and should take consent of the existing investors if such AIFs intend to invest in commodity derivatives.

These AIFs can participate in all commodity derivative products being traded in the such exchanges as ‘clients’ and should be subjected to all the rules, regulations and instructions applicable to clients. They should have position limits as applicable to clients.

“Category III AIFs may engage in leverage or borrow subject to consent from the investors in the fund and a maximum limit, as specified by the Sebi from time to time... Presently, the leverage of a category III AIF shall not exceed two times of the NAV (net asset value) of the fund," Sebi said.

The regulator has “proposed to allow participation of category III AIFs in the commodity derivatives market", it said in the draft papers.

Category III AIFs are those that employ diverse or complex trading strategies and may employ leverage, including through investment in listed or unlisted derivatives.

The Securities and Exchange Board of India (Sebi) has sought views from the public by 20 May on the proposal and the final norms will be put in place after taking into consideration suggestions of all the stakeholders.

The proposal has been made after taking into account suggestions of Sebi’s Commodity Derivatives Advisory Committee (CDAC). The regulator had set up the committee to advise it for effectively regulating and developing the commodity derivatives market.

The panel has advised that the commodity derivatives market should be opened up to institutional participation — both domestic as well as international — in a phased manner.

“The Indian commodity derivatives market at present is running sans any institutional participation and thereby is lacking in the desired liquidity and depth, which is one of the key elements for the efficient price discovery and price risk management," Sebi said.