After a series of credit events, SEBI has come up with a slew of measures to make debt funds safer.
The list of measures include fund houses reducing dependency on credit rating agencies and have an in-house system to assess credit risk.
In a circular today, SEBI said that the internal policy of a fund house should have adequate provisions to generate early warning signals including yield-based alerts on deterioration of credit profile of the issuer. Based on the alerts, the AMCs should respond appropriately and report it to their respective trustees.
Moreover, the market regulator has asked fund houses to reduce their holding in not so safe debt instruments.
The investment of mutual fund schemes in the following instruments cannot exceed 10% of the debt portfolio of the schemes and the fund house exposure in such instruments should not exceed 5% of the debt portfolio of all its schemes:
- Unsupported rating of debt instruments (i.e. without factoring-in credit enhancements) is below investment grade
- Supported rating of debt instruments (i.e. after factoring-in credit enhancement) is above investment grade
Experts feel the objective is to curb a debt scheme’s exposure to credit risk and discourage fund houses from chasing higher returns.
MF researcher Vidya Bala said that these measures are welcome steps particularly for short-term funds, as the objective of investment here is capital preservation.
Another notable measure is that AMCs need to ensure that the investment in debt instruments having credit enhancements have a minimum cover of 4 times.
“AMCs may ensure that the investment in debt instruments having credit enhancements are sufficiently covered to address the market volatility and reduce the inefficiencies of invoking of the pledge or cover,” the circular noted.
“This is a message from SEBI that it is not pleased with what happened in the case of Essel group and it does not like the LAS concept. This measure will certainly discourage creditworthy promoters to strike a deal with MFs. In case of other financial institutions such as banks and NBFCs, the limit is a cover of two times. So I don’t think why one should come to MFs,” a senior fund manager said requesting anonymity.
“Returns are likely to come down for all categories, but not by a considerable quantum,” he added.
Moreover, to make portfolio of MF schemes more transparent, SEBI has asked fund houses to provide details of investments in debt instruments having structured obligations or credit enhancement features in the monthly portfolio statement of MF schemes.
Here are a few other measures that the market regulator has announced:
On unlisted debt instrument
- MF scheme should not invest in unlisted debt instruments including commercial papers (CPs). They can only invest in listed and to be listed debt instruments.
Debt expert Joydeep Sen feels this does not necessarily restrict a fund house from investing in their desired securities, as a fund house can always ask the issuer to get listed.
Sen added that one should not consider all the listed securities to be liquid.
- However, no such rule applies to investment in unlisted government securities, other money market instruments and derivative products such as Interest Rate Swaps (IRS), Interest Rate Futures (IRF), which are used by mutual funds for hedging.
- Mutual fund schemes can also continue to invest in unlisted NCDs. However, such investments is capped at 10% of the debt portfolio of the scheme
- Investment in unlisted NCDs is subject to the condition that such unlisted NCDs have a simple structure (i.e. with fixed and uniform coupon, fixed maturity period, without any options, fully paid up upfront, without any credit enhancements or structured obligations) and are rated and secured with coupon payment frequency on monthly basis
- Debt schemes having more than 10% exposure to unlisted NCDs have to bring down their holding to 15% by March 31, 2020 and to 10% by June 20, 2020
- The existing investments of mutual fund schemes in unlisted debt instruments, including NCDs, may be grandfathered till maturity date of such instruments i.e. can be held till maturity
Unrated debt instruments
- MFs cannot invest in unrated debt and money market instruments other than instruments such as bills rediscounting that are generally not rated and for which separate investment norms or limits are not provided in SEBI regulations
- Investment in such instruments cannot exceed 5%. Currently, if a scheme exceeds the 5% limit then investments of the scheme will be grandfathered until maturity of such instruments
- However, fund houses can invest in unrated government securities, treasury bills, and derivative products such as Interest Rate Swaps (IRS), Interest Rate Futures (IRF)
Sector level exposure limits
Investment limit in a particular sector has been reduced to 20% as against 25%.
The additional exposure limits provided for HFCs in financial services sector has been capped at 10% as against 15%. Further, an additional exposure of 5% of the net assets of the scheme has been allowed for investments in securitized debt instruments based on retail housing loan portfolio and/or affordable housing loan portfolio. However the overall exposure in HFCs shall not exceed the sector exposure limit of 20% of the net assets of the scheme
Group level exposure limits
The investments by debt mutual fund schemes in debt and money market instruments of group companies of both the sponsor and the asset management company is restricted to 10% of the net assets of the scheme. Such investment limit can touch 15% of the net assets of the scheme with the prior approval of the board of trustees.
