Securities and Exchange Commission (SEC) logo

THE Securities and Exchange Commission (SEC) is seeking to revise rules on financial derivatives to “improve the regulatory compliance of investment companies and their fund managers and ensure adequate protection to shareholders and unitholders.”

The country’s corporate regulator released draft rules on investment in financial derivatives last Friday.

“[T]he Commission seeks to align the rules with global standards and practices in order to develop the Philippine capital market that will help prepare the investment companies qualify and compete in international cross-border transactions,” the SEC said.

At present, the implementing rules and regulations (IRR) of Republic Act No. 2629 or the Investment Company Act provides the basic rules for financial derivatives.

Derivatives are types of investments wherein an investor does not own the underlying asset, but instead makes a bet on the direction of the price movement of the underlying asset through an agreement with another party.

The SEC’s draft rules include additional requirements for financial derivatives and investment limits in the security.

Under the draft, the underlying of a financial derivative should also include the “rate of inflation, calculated, endorsed or determined by a government or government agency.” The underlying of a derivative currently consists of eligible assets, financial indices, foreign exchange rates or currencies and interest rates.

The SEC also proposed to include a limit on investments in over-the-counter (OTC) financial derivatives issued by any single business group. A qualifying collective investment scheme (CIS) must not invest, in aggregate, more than 20% of its net assets in OTC financial derivatives, in addition to transferable securities, money market instruments and deposits.

Also, the corporate regulator proposes to increase the aggregate limit to 15% from 10% for investments in deposits placed with unrated or non-investment grade institutions; unrated debt securities or those that are not dealt in an organized market; in unlisted shares; and OTC financial derivatives with non-investment grade or unrated counterparty.

“For the avoidance of doubt, the exposure to a counterparty of an OTC financial derivative should be measure based ‘on the maximum potential loss that may be incurred by the qualifying CIS if the counterparty defaults,’” the draft read.

In terms of risk management, the SEC is looking to raise the limit for global exposure of financial derivatives to 20% of the net assets of the investment company from 10% previously.

The SEC said the investment company is expected to be capable of meeting its payment and delivery obligations at all times. Its exposure to the underlying assets must not exceed, in aggregate, the investment limits as previously set in the Investment Company Act.

The corporate regulator is also putting a limit to the maximum exposure of an investment company in the counterparty of a financial derivative: it must not go above 10% of the company’s net assets if the counterparty has a minimum long-rating of investment grade, otherwise the limit is 5%.

The SEC is seeking comments from the public until Feb. 7. — Denise A. Valdez