News & Updates

SEC Issues Rules on Investment in Financial Derivatives

Financial derivatives, such as stock options, warrants and futures, are commonly used in the Philippine capital market. To improve the regulatory compliance of investment companies and their fund managers and protect shareholders and unitholders, the Securities and Exchange Commission (“SEC”) has issued SEC Memorandum Circular No. 15, Series of 2020 (“SEC MC 15”) providing for the Rules on Investment in Financial Derivatives. SEC MC 15 enhances the existing basic rules on financial derivatives under the Implementing Rules and Regulations (“IRR”) of Republic Act No. 2629, otherwise known as the Investment Company Act (“ICA”).

The term “financial derivative” is now defined under SEC MC 15 as “a financial instrument which derives its value from, or whose value depends on, the characteristics of one or more underlying assets, reference rates or indices.” To illustrate, stock options and warrants are financial derivatives since their value is based on the underlying shares or asset.

The salient provisions of SEC MC 15 are discussed below.

  1. Expanded Requirements for Financial Derivatives

SEC MC 15 provides for requirements that must be satisfied where the underlying asset of the financial derivative is an index. In particular, the index must meet the following requirements:

  1. Comprises eligible assets and commodities;
  2. Be diversified such that the maximum weight per constituent does not exceed thirty percent (30%) of the index or the underlying securities should have the same weight as the index;
  3. Be developed by an independent and reputable agency, or unit within a financial institution or conglomerate that is independent from the asset management unit, provided that the fund manager shall have a system or effective arrangement in place to manage potential conflicts of interest and based on a recognized and accepted methodology;
  4. Represent an adequate benchmark for the market and is widely accepted in international financial markets;
  5. The index value is published daily through media, which disseminates information in a timely manner and is accessible either publicly or on a subscription basis; and
  6. Information on the index is published and readily accessible.


  1. Investment Limits

The investment limits under the ICA IRR have been clarified by rules to determine the single group business limit and aggregate limit. A single business group is defined under SEC MC 15 as “a company, its subsidiaries, fellow subsidiaries, parent company and ultimate parent company.” Under the single business limit, an investment company must not invest, in aggregate, more than twenty percent (20%), in general, of its net assets in: (a) transferable securities; (b) money market instruments; (c) deposits; and (d) over-the-counter (“OTC”) financial derivatives issued by any single business group. Meanwhile, under the aggregate business limit, investments in certain derivatives enumerated under Section 2.2 of SEC MC 15 must not, in aggregate, exceed fifteen percent (15%) of the net assets of the investment company.

The Appendix to SEC MC 15 set outs the method for calculating an investment company’s global exposure to financial derivatives or embedded financial derivatives, which is generally limited by SEC MC 15 to not more than twenty percent (20%) of the net assets of the investment company.

  1. Embedded Financial Derivatives

SEC MC 15 provides for the following criteria to determine whether a component of a transferable security or money market instrument is considered to be embedding a financial derivative.

  1. The component results in some or all of the cash flows that otherwise would be required by the transferable security or money market instrument which functions as host contract to be modified according to a variable set out under SEC MC 15, and therefore vary in a way similar to a stand-alone financial derivative;
  2. The component’s economic characteristics and risks are not closely related to the economic characteristics and risks of the host contract; and
  3. The component has a significant impact on the risk profile and pricing of the transferable security or money market instrument.

Further, where an instrument is structured as an alternative to an OTC financial derivative or tailor-made to meet the specific needs of a scheme, the instrument should be deemed as embedding a financial derivative.