In the wake of recent credit events in debt funds, SEBI has recently proposed a few measures. We talked to industry experts to understand the impact of these rules on the MF industry.
Here are the proposed changes and their likely impact:
Proposal: Liquid funds to keep 20% of their AUM in safer assets such as cash, government securities and T-bills.
Impact: It will increase the ability of liquid funds to handle significant redemption pressure.
Proposal: Exposure of a scheme to individual sectors to be capped at 20% from 25%.
Impact: Portfolios diversification and reduce concentration risk in debt funds.
Proposal: Additional exposure of 15% to HFCs to be restructured to 10% in HFCs and 5% in affordable housing.
Impact: In 2017, SEBI increased the additional exposure limit for debt funds in HFCs from 10% to 15%. This was done to support funding for the affordable housing segment. However, many HFCs have increased their lending to real estate companies, which has exposed MF investors to higher risk.
The proposed changes would reduce MF investors’ exposure to higher risk papers while keeping the objective of giving a boost to affordable housing on track.
Proposal: Valuation of all debt and money markets to be marked-to-market.
Impact: NAVs of debt funds will be closer to reality and investors would get a truer picture of their investment.
The changes would also mean that liquid funds would be more volatile than ever.
Earlier this year, SEBI had asked AMCs to use amortization method only for valuation of bonds with a residual maturity of 30 days. Due to this valuation method, NAVs of liquid funds is currently comparatively less volatile.
Proposal: MFs can levy graded exit load on investors of liquid schemes, who exit the scheme within 7 days. Graded exit load means exit load on redemption will reduce by each passing day and there will be no exit load after seven days.
Impact: Many institutional investors were parking their money in liquid funds for less than 7 days. With the proposed change, these investors are likely to migrate to overnight funds.
Industry experts said that currently, liquid funds have AUM of Rs.5.40 lakh crore. Of this, institutional investors have parked close to 30% of the total AUM for less than 7 days. With the new rules, AUM of liquid funds are going to shrink while overnight funds will benefit the most.
They further said that levying exit load on liquid funds is not desirable as this is a cash management product.
Proposal: Liquid schemes and overnight schemes cannot invest in short-term deposits and money market instruments having structured obligations such as retail loans backed by a lender or credit enhancements like loan against shares (LAS).
Impact: This is a move to enhance the credit quality of these funds. Even today, most liquid funds and overnight funds do not have exposure to such instruments. But now this rule will make it mandatory for them to stay away from such investments. A few other changes have also been proposed to improve the credit quality of debt funds.
- MF schemes can only invest in listed NCDs. Incremental investments in Commercial Papers (CPs) have to be only in the listed ones.
- In case of investment in LAS, fund houses will have to maintain at least 4 times cover for such investments. For instance, debt funds can lend Rs.100 crore after pledging shares worth Rs.400 crore.
-Total investment by a scheme in debt and money market instruments having credit enhancements has been capped at 10% of the scheme’s debt portfolio. For a particular group, the limit is set at 5%.
