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CIS 5A.7 Geared futures and options schemes

Application

CIS 5A.7.1R

Introduction

CIS 5A.7.2G
  1. (1)

    This section (CIS 5A.7) sets out specific rules for geared futures and options schemes. Geared futures and options schemes are authorised fundsdedicated to investment in derivatives (whether with or without transferable securities) where the extent of that investment is limited by the amount of property available to be put up as initial outlay or used as cover.

  2. (2)

    A geared futures and options scheme is permitted to take on exposure to the extent of putting 20% of its scheme property into initial outlay on derivatives. The property for this purpose is not to be increased by borrowing, since a geared futures and options scheme cannot borrow (see CIS 5A.15.3 R (General power to borrow)). There is no limit on the amount of cash that can be held by the geared futures and options scheme.

Geared futures and options scheme: general

CIS 5A.7.3R
  1. (1)

    The scheme property of a geared 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 investments in units in collective investment schemes under CIS 5A.4.5 R);

    2. (b)

      transactions in derivatives or forward transactions which are covered on the basis available to a futures and options scheme (see CIS 5A.6.9 R - CIS 5A.6.12 R for requirements for cover);

    3. (c)

      derivatives permitted under the rules in this section (CIS 5A.7);

    4. (d)

      forward transactions in currencies or gold permitted under the rules in this section (CIS 5A.7);

    5. (e)

      cash or near cash;

    6. (f)

      units in collective investment schemes under CIS 5A.7.8 R(Investment in collective investment schemes);

    7. (g)

      gold.

  2. (2)

    In respect of investment within (1)(a), CIS 5A.4 (Securities schemes) applies as if the geared futures and options scheme were a securities scheme, but subject to any special modifications in this section (CIS 5A.7).

  3. (3)

    In respect of transactions in derivatives and forward transactions under (1)(b), CIS 5A.6 (Futures and options schemes), except CIS 5A.6.7 R (Investment in collective investment schemes), applies as if the geared futures and options scheme were a futures and options scheme, but subject to any special modifications in this section ( CIS 5A.7).

  4. (4)

    In respect of derivatives within (1)(c):

    1. (a)

      any transaction in derivatives must be in an approved derivative, or in one which complies with CIS 5A.6.6 R (OTC transactions in derivatives); and

    2. (b)

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

  5. (5)

    In respect of transactions within (1)(d), this section (CIS 5A.7), except (4) and CIS 5A.7.4 R (7) (Limit on investment in initial outlay), applies as if any forward transaction were a transaction in derivatives; and the transaction must be with a counterparty which is approved for the purposes of CIS 5A.6.6 R (2).

  6. (6)

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

  7. (7)

    The following also apply to geared 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).

  8. (8)

    Despite the rules referred to in (7), an ICVC that is a geared futures and options scheme or the trustee of an AUT that is a geared futures and options scheme does not have power to borrow, whether under this section (CIS 5A.7) or CIS 5A.13 (Efficient portfolio management) or otherwise.

Limits on investment in initial outlay

CIS 5A.7.4R
  1. (1)

    At any time, not more than 20% in value of the scheme property of a geared futures and options scheme is, subject to (3), to be devoted to initial outlay in any transactions in derivatives which are outstanding.

  2. (2)

    For the purposes of initial outlay:

    1. (a)

      regard must be had to the rules of any relevant eligiblederivatives market;

    2. (b)

      any increase in margin or initial margin, if required by such a market, is regarded as initial outlay from then on;

    3. (c)

      any decrease in margin or initial margin, if allowed by such a market, ceases to be initial outlay from then on;

    4. (d)

      variation margin (that is, an additional sum required to be paid to retain the rights following a movement in prices or other movements) is not initial outlay;

    5. (e)

      premium which may become payable in the future under the transaction in respect of an option is regarded as initial outlay from the outset;

    6. (f)

      in the case of a purchased option, the amount mentioned in (6) is to be regarded as initial outlay;

    7. (g)

      in the case of a written option, the amount mentioned in (7) is to be regarded as initial outlay;

    8. (h)

      in the case of an over the counterfuture, the amount mentioned in (8) is to be regarded as initial outlay; and

    9. (i)

      in the case of a forward transaction, the amount mentioned in (9) is to be regarded as initial outlay.

  3. (3)

    Not more than 10% in value of the scheme property is to be used for initial outlay on transactions in derivatives in the form of purchased options without counting this towards the 20% in (1). The figure of 10% must be reduced by any percentage of the value of the scheme property invested in transferable securities in the form of warrants.

  4. (4)

    The authorised fund manager must arrange for the depositary to deposit and set aside with an eligible institution or an approved bank the amounts for the time being required by (6), (7), (8) and (9), and these amounts must not be used for the purpose of providing cover under the rules in this chapter.1

  5. (5)

    The amounts 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).

  6. (6)

    Where an option is purchased for the account of the ICVC or of the AUT, the authorised fund manager must ascertain the amount, if any, by which 5% of the exercise value of the option (that is the amount which would be payable or receivable by the geared futures and options scheme on exercise of the option) exceeds the amount paid by way of premium.

  7. (7)

    Where an option is written for the account of the ICVC or of the AUT, the authorised fund manager must ascertain at the outset and at each valuation the amount which is the sum of:

    1. (a)

      5% of the exercise value of the option (that is the amount which would be payable or receivable by the purchaser of the option, on exercise of the option); and

    2. (b)

      the amount, if any, by which the option is in the money to the purchaser of the option.

  8. (8)

    Where a transaction in an over the counterfuture is entered into for the account of the ICVC or of the AUT, the authorised fund manager must ascertain at the outset and at each valuation the amount which is the sum of:

    1. (a)

      5% of the value of the amount of property to be bought or sold under the contract; and

    2. (b)

      the amount, if any, by which the future would cause a loss to the geared futures and options scheme if it were to be closed out.

  9. (9)

    Where a forward transaction is entered into for the account of the ICVC or of the AUT, the authorised fund manager must ascertain at the outset and at each valuation the amount which is 5% of the value of the forward contract (that is the amount of currency or of gold to be purchased or sold by the transaction at the current valuation in the currency or one of the currencies relevant for the purposes of the transaction) for each period of three months (or part of them) between the date of the latest valuation and the date of maturity.

Stages in using limit on initial outlay

CIS 5A.7.5G

CIS 5A.7.6 G sets out the various stages in using initial outlay

CIS 5A.7.6G

Stages in using limit on initial outlay

This table belongs to CIS 5A.7.5 G

Calculating maximum limit on initial outlay

Example 1 - Start point

Take the value of the scheme property (£10 million)

Divide by 20% to find limit (£10m) 20% = £2million.

Note:

(1)

In general, potential exposure of the geared futures and options scheme will increase with any increase in initial outlay.

(2)

If the value of the scheme property changes on a subsequent valuation, the maximum permitted initial outlay will also change as shown in Example 2 and Example 3.

Example 2 - Successful scheme

The scheme is subsequently valued at £12 million. Corresponding value of initial outlay becomes: -

20% of £12 million = £2.4 million.

Example 3 - Unsuccessful scheme

The scheme is subsequently valued at £8 million. Corresponding value of initial outlay becomes:-

20% of £8 million = £1.6 million.

Spread

CIS 5A.7.7R
  1. (1)

    There are no limits, other than those resulting from the requirement in CIS 5A.7.4 R (Limit on investment in initial outlay), on the value of the scheme property of a geared futures and options scheme which may be devoted to initial outlay in respect of derivatives on or related to any one category of underlying security, commodity or other factor.

  2. (2)

    Not more than 5% in value of the scheme property of a geared futures and options scheme is to be devoted to initial outlay in respect of over the counter transactions with any one counterparty.

  3. (3)

    Wherever the total value held on deposit of the scheme property of a geared 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)

      for the purposes of (a):

      1. (i)

        the depositary and its associates are regarded as the same 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 (5) 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); and1

      2. (ii)

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

Investment in collective investment schemes

CIS 5A.7.8R
  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 geared 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 authorised funds; 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 scheme: investment in collective investment schemes); or

      2. (ii)

        would be within CIS 5A.4.5 R if CIS 5A.4.5 R (3)read: "is dedicated to investing funds raised from the public:

      (a) in approved and other derivatives (where most or all of the transactions in derivatives are fully covered by cash, securities and other derivatives), whether with or without transferable securities or covered forward transactions in currency or gold; or(b) in approved and other derivatives (where the extent of investment is limited by the amount of scheme property available to be put up as initial outlay), whether with or without transferable securities and whether with or without investment within (a)".

  2. (2)

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

Delivery of property under a transaction in derivatives

CIS 5A.7.9R
  1. (1)

    When entering into any transaction in derivatives as a result of which any investment or asset may become part of the scheme property of the geared futures and options scheme, the authorised fund manager must take reasonable care to determine:

    1. (a)

      (where the investment or asset is one of which the scheme property could in some measure consist) that the transaction will not result in any breach of any other rule in this chapter:

      1. (i)

        because it can be readily closed out; or

      2. (ii)

        because the investment or asset concerned will at the expected time be included within the scheme property in a manner which conforms with the rules in this chapter; or

    2. (b)

      (in any other case) that the transaction can readily be closed out.

  2. (2)

    Where, in the event, the determination in (1)(a) or (1)(b) proves unjustified, and the authorised fund manager decides with the consent of the depositary, in accordance with CIS 7.5.3 R (Duties of the ACD and depositary: investment and borrowing powers) (in the case of an ICVC) or CIS 7.10.3 R (Duties of the manager and trustee: investment and borrowing powers) (in the case of an AUT) that it is in the interests of the holders that the property should be temporarily acquired, then the property concerned may, despite any other rule in this chapter, form part of the scheme property until the position can be rectified.