Why in news?
The Securities and Exchange Board of India (SEBI), in its recent meeting, has tightened the rules for debt mutual funds.
What are debt mutual funds?
- There are different types of Mutual Funds that invest in various securities, depending on their investment strategy.
- Debt Mutual Funds mainly invest in a mix of debt or fixed income securities.
- These may include Treasury Bills, Government Securities, Corporate Bonds, Money Market instruments and other debt securities of different time horizons.
- Generally, debt securities have a fixed maturity date and pay a fixed rate of interest.
- The returns of a debt mutual fund comprises of -
- Interest income
- Capital appreciation / depreciation in the value of the security due to changes in market dynamics
What is the rationale behind the new rules?
- Payment defaults by Infrastructure Leasing and Financial Services Ltd led to the liquidity crisis in India’s shadow banking industry.
- Following this, mutual funds that had lent heavily to the non-bank lenders rushed to cut their exposure.
- However, mutual funds continue to have a massive Rs. 3.12 trillion exposure to NBFCs and housing finance companies.
- Given the uncertainty in this sector, the SEBI’s rules now seek to de-risk liquid funds.
- The move aims at protecting investors from credit risks arising out of defaults by borrowers.
- SEBI’s latest changes will have a significant impact on India’s Rs. 25.93 trillion mutual fund industry.
What are the key changes?
- Investment - Liquid funds can invest a maximum of 20% of their assets in a single sector as against the current cap of 25%.
- [Liquid funds are debt mutual funds that can invest in securities up to a maturity of 91 days.]
- They must keep aside at least a fifth of their assets in cash equivalents to meet sudden redemption pressures.
- The mutual fund industry has to comply with the new sectoral caps from September 2020.
- [The changes are based on recommendations made by the mutual fund advisory committee constituted by SEBI to limit liquid fund exposure to a single sector.
- This is especially in reference to the non-banking finance companies (NBFCs) catering to the housing sector.]
- It will also be mandatory for all mutual fund schemes post September 2020 to invest only in listed non-convertible debentures and commercial papers.
- This measure is aimed at ensuring more transparency.
- Liquid and overnight schemes cannot invest in short-term debt and money market instruments, according to the new rules.
- Credit-enhanced securities - SEBI has reduced liquid funds’ exposure to the credit-enhanced securities to 10% of AUM (assets under management).
- A credit enhancement is typically a promoter guarantee or the offer of shares as collateral in order to enhance the creditworthiness of specific debt paper.
- These are also referred to as loan against shares (LAS).
- The mutual fund industry currently has an exposure of around Rs. 50,000 crore to loans against shares.
- Valuation - SEBI has also finalized a uniform valuation policy for debt instruments.
- Currently, once the security falls below the investment grade, fund managers end up writing off papers as per their discretion.
- The new valuation framework plans to do away with this.
- Own trades or so-called self trades will also not be allowed to boost valuation of the paper.
Source: Livemint
Related News: Fixed Maturity Plans (FMPs) - Default, SEBI's New Rules on Liquid Funds
