Hungarian investment funds and their managers are subject to Act LXIII of 1991 on Investment Funds (the Investment Funds Act). Under the Investment Funds Act it is unclear to what extent investment funds may enter into derivative transactions. In order to stimulate the market the Hungarian capital market authority, now called the State Supervisory Authority of Financial Organizations, has issued a guidance note setting out the circumstances under which investment funds may enter into derivative transactions.
Under the guidance notes an investment fund may only enter into derivative transactions if the particular transaction is in accordance with its investment policy. Also, the purpose of the transaction must be to reach the investment targets specified in such an investment policy. A derivative transaction entered into by investment funds must meet one of three criteria:
- it limits the exposure arising from investments in securities; or
- it decreases the cost of creating the portfolio in accordance with the investment policy of the fund (efficient portfolio management) or results in additional risk-free income for the fund (arbitrage); or
- the transaction results in the closing of another derivative position.
In order to limit the exposure in connection with the investments in securities, a fund may enter into the following derivative transactions:
- forward sale of securities or purchase of call options on securities;
- the sale of index futures contracts or the purchase of call options on index futures contracts, provided that the link between the futures contracts/index and the securities portfolio to be hedged is clear;
- forward sale of government securities or the purchase of call options on government securities, provided that the purpose of the purchase is to secure the investment of cash flows to be received on the government securities concerned and upon receipt of the cash flows, the relevant derivative contract is terminated;
- forward, futures, option and swap transactions (in order to limit the foreign exchange exposure of investments in foreign currencies);
- the sale of call options so that the fund may receive at least an option premium even if the prices of the securities in the fund are decreasing.
For the purposes of efficient portfolio management the fund may enter into the following transactions:
- forward sale (or sale of a futures contract) and purchase of put options, provided that such transactions can be entered into with more favourable terms than a prompt (cash) transaction. Such derivative transactions must be closed out/terminated within six months;
- forward sale or purchase of debt securities or the purchase of call or put options on debt securities, provided that the purpose of such transactions is to secure the contemplated term structure. The term of such transactions may not exceed two years;
- swap transactions, provided that the term of such transactions may not exceed two years; and
- interest rate arbitrage, provided that no part of the transaction may have a term exceeding two years.
The total market value of the outstanding derivative transactions entered into by the fund may not exceed 10% of the equity of the investment fund.
If the term of an interest rate or index derivative transaction is longer than six months, such a transaction may only be a futures (exchange traded) transaction. Parties entering into a derivative transaction may only specify physical delivery, unless the transaction is a futures (exchange traded), foreign exchange, index-linked, interest rate or a swap transaction.
Investment funds must request collateral from their derivative counterparties. If there is more than one transaction between the same counterparties, only the net in-the-money position must be collateralized. Fund managers are not required to request collateral from counterparties specified by the Authority or graded at least BBB by recognized credit rating agencies. Also, fund managers are not required to request collateral if the exposure to the counterparty is within the limit specified for that particular counterparty in the internal regulations of the relevant fund manager. Non-collateralized transactions may not exceed 5% of the equity of the investment fund.
The collateral may be cash, deposits or government securities with a term not longer than one year. Such securities may be taken into account as collateral at market value. Only 95% of the market value of government securities with a term exceeding one year may be taken as collateral. The collateral must be delivered to a depository and must be held separately from other assets of the fund.