CIS 5A.6 Futures and options schemes

This section (CIS 5A.6) applies to authorised fund managers of futures and options schemes except:

1. (1)

   CIS 5A.6.6 R (3), which also applies to depositaries of futures and options schemes; and

2. (2)

   CIS 5A.6.14 R, which applies to ICVCs that are futures and options schemes and to trustees of AUTs that are futures and options schemes.

1. (1)

   The scheme property of a futures and options scheme must, except where otherwise provided in the rules in this chapter, consist only of any or all of:

   1. (a)

      transferable securities available to a securities scheme, in accordance with CIS 5A.4 (Securities schemes) (but excluding investment in units in collective investment schemes under CIS 5A.4.5 R);

   2. (b)

      derivatives permitted under this rule (CIS 5A.6.3 R) and CIS 5A.6.4 R - CIS 5A.6.6 R;

   3. (c)

      forward transactions in currencies or gold permitted under this rule (CIS 5A.6.3 R), CIS 5A.6.4 R and CIS 5A.6.5 R;

   4. (d)

      cash or near cash;

   5. (e)

      units in collective investment schemes under CIS 5A.6.7 R (Investment in collective investment schemes); and

   6. (f)

      gold.

2. (2)

   For investment within (1)(a), CIS 5A.4 (Securities schemes) applies as if the futures and options scheme were a securities scheme, but subject to any specific modification in this section (CIS 5A.6).

3. (3)

   For investment within (1)(b) or (1)(c), a transaction in derivatives or a forward transaction must not be effected unless:

   1. (a)

      the transaction is of the kind specified in CIS 5A.6.4 R (Permitted transactions); and

   2. (b)

      the transaction is:

      1. (i)

         fully covered, as required by CIS 5A.6.9 R (Cover for transactions in derivatives and forward transactions); or

      2. (ii)

         the subject of deposit arrangements, as required by CIS 5A.6.13 R (Deposit arrangements (for purchased options)).

4. (4)

   Not more than 10% in value of the scheme property is to be used for transactions in derivatives in the form of uncovered purchased options (taking the current market value of the option as its value for this purpose), but there must be deducted from that figure of 10% any percentage of the value of the scheme property invested in transferable securities in the form of warrants.

5. (5)

   Not more than 10% in value is to be held in the form of gold.

6. (6)

   Whenever the total value held on deposit of the scheme property of a futures and options scheme is more than £1 million:

   1. (a)

      not more than 10% in value is to be kept as cash on deposit with any one person;

   2. (b)

      in (a):

      1. (i)

         the depositary and its associates are regarded as one person;

      2. (ii)

         the manager and its associates are regarded as one person; and

      3. (iii)

         each director of an ICVC including the ACD and his or its associates are regarded as one person; and

   3. (c)

      the figure of 10% in (a) may be increased to 20% if:

      1. (i)

         the person is an eligible institution or an approved bank and is not one of the persons referred to in (b); and

      2. (ii)

         the amount of the deposit does not exceed 10% in value of that eligible institution's or an approved bank's issued capital and reserves as shown in its most recently published annual accounts.1

7. (7)

   The following also apply to futures and options schemes:

   1. (a)

      CIS 5A.2 (General investment powers and limits for authorised funds);

   2. (b)

      CIS 5A.13 (Efficient portfolio management);

   3. (c)

      CIS 5A.14 (Stock lending);

   4. (d)

      CIS 5A.15 (Cash, borrowing, lending and other provisions); and

   5. (e)

      CIS 5A.16 (Cover for sales).

1. (1)

   A transaction in derivatives under this section (CIS 5A.6) must be:

   1. (a)

      in an approved derivative; or

   2. (b)

      one which complies with CIS 5A.6.6 R (OTC transactions in derivatives); or

   3. (c)

      a synthetic future.

2. (2)

   Any transaction in an approved derivative must be effected on or under the rules of an eligiblederivatives market.

3. (3)

   Any forward transaction must be with an approved counterparty under CIS 5A.6.6 R (2)(OTC transactions in derivatives).

4. (4)

   Not more than 5% in value of the scheme property is to be directed to initial outlay in respect of over the counter transactions with any one counterparty.

A derivatives or forward transaction (which is a permitted transaction under CIS 5A.6.4 R (Permitted transactions (derivatives and forwards)) which will or could lead to delivery of property for the account of the ICVC or to the trustee for the account of the AUT may be entered into only if:

1. (1)

   that property can be held for the account of the ICVC or can be held by the AUT (or else the transaction is a bought future or bought call option); and

2. (2)

   the authorised fund manager having taken reasonable care determines that delivery of the property under the transaction will not occur or will not lead to a breach of the rules in this sourcebook.

Any transaction in derivatives under CIS 5A.6.4 R (1)(b)must be:

1. (1)

   a future or an option or a contract for differences resembling an option;

2. (2)

   with an approved counterparty; a counterparty to a transaction in derivatives is approved only if the counterparty is:

   1. (a)

      an eligible institution or an approved bank; or1

   2. (b)

      a firm whose permission (including any requirements or limitations), as published in the FSA record, permits it to enter into the transaction as principaloff-exchange;

3. (3)

   on approved terms; the terms of a transaction in derivatives are approved only if, before the transaction is entered into, the depositary is satisfied that the counterparty has agreed with the ICVC or with the manager:

   1. (a)

      to provide a valuation in respect of that transaction (which, for dual-priced AUTs should be on a buying and selling basis) at least once a week and at any other time at the request of the ICVC or manager; and

   2. (b)

      that it will, at the request of the ICVC or manager, enter into a further transaction to close out that transaction, at a reasonable price arrived at under the pricing model or other reliable basis agreed under (4); and

4. (4)

   capable of valuation; a transaction in derivatives is capable of valuation only if the authorised fund manager having taken reasonable care determines that, throughout the life of the derivative (if the transaction is entered into), it will be able to value the investment concerned with reasonable accuracy:

   1. (a)

      on the basis of a pricing model which has been agreed between the authorised fund manager and the depositary; or

   2. (b)

      on some other reliable basis reflecting an up-to-date market value which has been so agreed.

1. (1)

   Investments in units of a collective investment scheme must not be made unless that scheme:

   1. (a)

      is a regulated collective investment scheme which is either a futures and options scheme or a money market scheme or a scheme of a category that is equivalent to the category of one of such schemes; or

   2. (b)

      (after taking account of CIS 5A.2.10 R) (Investment in associated collective investment schemes):

      1. (i)

         is within CIS 5A.4.5 R (Securities schemes: investment in collective investment schemes); or

      2. (ii)

         would be within CIS 5A.4.5 R (Securities schemes: investment in collective investment schemes) if paragraph (3) of that rule read: "is dedicated to investing funds raised from the public in approved and other derivatives (where most or all of the transactions in derivatives are fully covered by cash, securities or other derivatives) whether with or without transferable securities or covered forward transactions in currency or gold."

2. (2)

   Not more than 5% in value of the scheme property of a futures and options scheme is to consist of units in collective investment schemes.

1. (1)

   Except where CIS 5A.6.13 R (1) (Deposit arrangements (purchased options)) applies, a transaction in derivatives or forward transaction is to be entered into under this section (CIS 5A.6) only if the maximum potential exposure created by the transaction, in terms of the principal or notional principal of the derivative contract or forward contract, is:

   1. (a)

      covered individually under (2) or (3); and

   2. (b)

      covered globally under (4).

2. (2)

   Exposure is covered individually if there is, in the scheme property:

   1. (a)

      (in the case of an exposure in terms of property) a transferable security or other property which is of the right kind, and sufficient in amount, to match the exposure; and

   2. (b)

      (in the case of an exposure in terms of money), cash or near cash (or borrowing under CIS 5A.6.14 R (Borrowing)) or transferable securities which is or are, or, on being turned into money in the right currency, will be, sufficient in amount to match the exposure.

3. (3)

   However, exposure to an index or basket of securities or other assets is covered individually for the purposes of (2) if the futures and options scheme holds transferable securities or other property which (taking into account the closeness of the relation between fluctuations in the price of the two) can reasonably be regarded as appropriate to provide cover for the exposure; they may be so regarded even if there is not complete congruence between the cover and the exposure.

4. (4)

   Exposure is covered globally if, after taking account of all the cover required under (2) or (3) for other positions already in existence, adequate cover from within the scheme property is available to enable the fresh transaction to be entered into.

5. (5)

   Whether or not a derivative or forward transaction is available under CIS 5A.6.12 R (Derivatives covering derivatives : requirements) to provide cover for another derivative or forward transaction under this section (CIS 5A.6):

   1. (a)

      the two transactions involved in a synthetic future are to be treated as if they were a single derivative, and the net exposure from the combination is to be covered on the basis of the higher of the cover requirements of the options which make up the synthetic future; and

   2. (b)

      synthetic cash is available to provide cover for a transaction as if it were cash.

6. (6)

   Cash not yet received into the scheme property but due to be received within one month is available as cover for the purposes of (2)(b) and (3).

7. (7)

   Property is not available for cover if it is the subject of a transaction under CIS 5A.14 (Stock lending), unless the authorised fund manager having taken reasonable care determines that it is obtainable (by return or re-acquisition) in time to meet the obligation for which cover is required.

1. (1)

   Where an authorised fund manager proposes to use a position resulting from a transaction in derivatives as cover (whether in whole or in part) for the exposure of another transaction in derivatives, CIS 5A.6.9 R (Cover for derivatives and forward transactions) has effect as modified by this ruleCIS 5A.6.12 R).

2. (2)

   On the basis that the requirements of CIS 5A.6.9 R (Cover for transactions in derivatives and forward transactions) about the amount and right kind of assets as cover are satisfied, (3) contains the requirements for the purposes of (1).

3. (3)
   1. (a)

      In this rule (CIS 5A.6.12 R) "countervailing" means that one of the two derivatives has an exposure which, in terms of risk, is equal and opposite to the exposure of the other, and "offset" means that there is an equal and opposite coverage in terms of risk.

   2. (b)

      A derivative of one type provides cover for a countervailing derivative of the same type.

   3. (c)

      A derivative of one type provides cover for a countervailing derivative of a different type if, but only if:

      1. (i)

         the right under one offsets and is offset by the obligation under the other; or

      2. (ii)

         Paragraph (g) applies.

   4. (d)

      In applying (b) and (c), differences between the derivatives in terms of price, maturity and exercise price may be ignored, except where (b) is disapplied by (e).

   5. (e)

      Paragraph (b) does not apply if an opportunity to exercise the right under the one derivative will become available to the futures and options scheme only after the first date on which the potential obligation under the other may become an actual obligation.

   6. (f)

      Where, under (b), an authorised fund manager decides that a written option and a bought option should provide mutual cover, the authorised fund manager must arrange for the depositary to deposit and set aside with an eligible institution or an approved bank the whole amount of the difference between the exercise value of the two options (that is the amount which would be payable by or to the futures and options scheme on exercise of the options) inclusive of any margin requirements of the exchange. That amount must not be used for the purposes of providing cover, other than under this paragraph (f), under the rules of this chapter.

   7. (g)

      A written option provides cover for, and is covered by, a countervailing future only if the option is in the money to the purchaser of the option. If the written option is out of the money to the purchaser, then both it and the future must each be separately covered under CIS 5A.6.9 R (Cover for transactions in derivatives and forward transactions).

   8. (h)

      A contract for differences may be included in this rule (CIS 5A.6.12 R) if and to the extent that it has the characteristics of a future or an option.1

1. (1)

   Where the purchase of an uncovered option is proposed in reliance on CIS 5A.6.3 R (4)(Futures and options schemes: general), the authorised fund manager must arrange for the depositary to deposit and set aside with an eligible institution or an approved bank any amount by which 5% of the exercise value of the option (that is the amount which would be payable by the futures and options scheme on exercise of the option) exceeds the amount paid by way of premium. That excess (if any) must not be used for the purposes of providing cover under the rules in this chapter.1

2. (2)

   The amount to be deposited and set aside may be in cash or in government and public securities (which are to be valued for this purpose at the current mark to market valuation).

1. (1)

   Cash obtained by borrowing, and borrowings which the authorised fund manager reasonably regards an eligible institution or an approved bank to be committed to provide, are available for cover under CIS 5A.6.9 R (Cover for transactions in derivatives and forward transactions) as long as the normal limits on borrowing (as to which see CIS 5A.15.3 R (General power to borrow) and CIS 5A.15.4 R (Borrowing limits)) are observed.1

2. (2)

   Where, for the purposes of this section (CIS 5A.6), the ICVC or the trustee for the account of the AUT on the instructions of the manager:

   1. (a)

      borrows an amount of currency from an eligible institution or an approved bank; and1

   2. (b)

      keeps an amount in another currency, at least equal to the borrowing for the time being in (a), on deposit with the lender (or his agent or nominee);

   then this section (CIS 5A.6) applies as if the borrowed currency, and not the deposited currency, were part of the scheme property, and the normal limits on borrowing under CIS 5A.15.3 R and CIS 5A.15.4 R do not apply to that borrowing.

1. (1)

   An authorised fund manager must, at each valuation point (and more frequently if necessary), re-calculate the amount of cover required in respect of derivatives and forward positions already in existence under this section (CIS 5A.6). Derivatives and rights under forward transactions under this section may be retained in the scheme property only so long as they remain covered both individually and globally under CIS 5A.6.9 R (Cover for transactions in derivatives and forward transactions) (or, where relevant, the deposit requirements in CIS 5A.6.13 R (Deposit arrangements (for purchased options)) are complied with).

2. (2)

   If at any time:

   1. (a)

      any fact or matter relating to the futures and options scheme or its economic environment; or

   2. (b)

      the aggregate of all outstanding derivatives or forward positions under this section;

   is such that at least one of the relevant transactions (assuming it did not exist) could not properly have been effected, either in that size or at all, the authorised fund manager must immediately on becoming aware of that fact or matter take the necessary steps to rectify the situation, whether by closing out or providing additional cover or otherwise.