SEBI is likely to tighten guidelines on debt funds to mitigate risk in such funds. In fact, the market regulator is reportedly deliberating the introduction side-pocketing and mark-to-market valuations of debt security having maturity of 30 days.
This has been discussed at a meeting of Mutual Fund Advisory Committee (MFAC) held today in Mumbai, said two people who have attended this meeting. An MFAC member told Cafemutual that there has been discussions on introducing side-pocketing and mark-to-market valuation in debt funds to reduce risk in debt funds. However, nothing has been finalized. He said that MFAC members would meet again this month to finalize this.
Side-pocketing is a practice in which fund houses can segregate risky assets from the rest of their holdings and cap redemptions. Simply put, fund houses can create two funds - one with risky assets where fund house will not allow redemption expecting recovery from stressed assets and another fund with other assets with existing features. This practice is prevalent among hedge funds in developed markets.
Since debt securities are illiquid in nature and not traded like equities, mark-to-market valuation is challenging for fund houses. However, they have to quote NAV on a daily basis. Hence, most fund houses rely on rating agencies to derive NAV. Often rating agencies look at accrual to value debt securities.
Currently, SEBI rules says that fund houses will have to do mark-to-market valuations of securities having maturity of up to 60 days and more. Liquid funds hold securities having maturity of up to 91 days. However, most liquid funds hold securities having maturity of less than 60 days. As a result, post IL&FS crisis, NAV of a few liquid funds witnessed a sharp decline due to mark-to-market loss.
Joydeep Sen, debt market analyst feels that fund houses will continue to rely on rating agencies to publish NAV of their liquid funds. “If SEBI makes it mandatory for fund houses to do mark-to-market valuation of securities having maturity of 30 days, most fund houses will hold papers of less than 30 days to avoid mark-to-market valuation. If fund houses will do mark-to-market valuations of all securities on a daily basis, liquid funds would start reflecting negative returns frequently.”
Another fund official told Cafemutual that SEBI would not introduce lock-in period in liquid funds. “There has been reports on introduction of lock in period in liquid funds. However, there is no such recommendations before MFAC.”
