What measures SEBI has taken to reduce risks in debt funds

Kavya Balaji   /   October 27, 2020
measures SEBI has taken to reduce risks in debt funds

After the Franklin Templeton Mutual Fund crisis this year, investors reduced their exposure to debt funds. The Franklin schemes were shut down because the fund house saw a surge in its redemptions. There were liquidity issues as the fund house was not able to sell its holdings to meet the redemption requests. This made investors wary of debt funds and they started believing that they may not get back their money. So, a number of investors avoided debt funds.

To make debt funds safer, the stock markets regulator Securities and Exchange Board of India (SEBI) has come out with a number of proposals and measures. These will not only help reduce the risk in debt mutual funds, it will improve the liquidity of debt funds too. Here are the measures that SEBI is taking.

No more inter scheme transfers without consideration

SEBI has restricted the use of inter-scheme transfers by debt mutual funds. Inter scheme transfers is transferring debt papers from one mutual fund scheme to another. Many fund houses have misused this whenever they had higher redemption requests. They used the inter scheme transfers to transfer papers from credit risk funds to other types of funds which have no credit risks.  As per data from SEBI, more than Rs, 60,000 crores have been transferred this financial year by debt mutual funds. The present rules say that fund houses can transfer debt papers if the transfer is in line with the investment objective of the recipient scheme.

However, SEBI’s new guidelines say that transfers from close ended funds can be done only within three business days of allotting the units of the scheme to investors. No transfers can be done after that. For open ended schemes, transfers will be allowed only if the fund house is facing higher redemptions or if there is a need to rectify regulatory limits. Even if the fund house wants to use transfers to meet redemptions, it needs to first use the cash of the scheme, market borrowings and sell securities before resorting to inter scheme transfers. The rules will be followed by mutual fund houses from January 1, 2021. This will improve risk management in debt funds.

Use of corporate bonds platform

SEBI has said that mutual fund houses should use the Request for Quote (RFQ) platform to trade in corporate bonds. This platform is available on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE).

RFQ is a platform that allows interaction among market participants. Using the platform, fund houses can negotiate corporate bond transactions. This will improve the liquidity of secondary market transactions on stock exchanges.

More disclosures

SEBI has said that debt mutual funds have to disclose their portfolio every fortnight. This was monthly earlier. Fund houses also need to disclose the yields of the underlying securities to increase the transparency of the scheme. Earlier, only the indicative yield of the entire portfolio was provided by the fund house.

Central repo clearing

A central repo clearing corporation will help mutual funds get money quickly. For instance, when a mutual fund has assets worth Rs. 1,000 crores or more and needs Rs. 100 crores to meet redemptions, it can sell its securities to get money or it can borrow using the repos.

SEBI is looking at setting up a central clearing corporation for repos. Fund houses can trade in investment grade corporate bonds (those that are BBB or higher).  The settlement will be guaranteed by the repo clearing corporation. So, mutual funds can borrow money using their securities when redemptions are high.

Funding help

SEBI is considering launching an entity that can buy illiquid debt when fund houses need help. Since the corporate debt market is illiquid, a crisis will make it more difficult. If an organization can fund asset management companies during that time, it will help fund houses as well as investors.

Minimum cash holding

SEBI has said that liquid funds need to hold at least 20 percent of their portfolio in liquid assets such as cash, treasury bills, etc. at all times. SEBI is considering extending this to other debt funds. SEBI has also said that there will be exit loads for investors that redeem money within seven days.

Swing pricing

This is proposed by SEBI to protect small investors. Swing pricing is where investors who make large redemptions in times of crises have to pay a cost for their redemptions. The fund house will adjust the Net Asset Value (NAV) of the fund in order to pass on the costs of trading to those investors making high redemptions. This will make sure that the value of small investors is not eroded by the transaction activity of others within the same fund.

Unlisted NCDs

SEBI has reduced the overall limit for the investment in unrated debt instruments to 5 per cent. Presently, fund houses can invest up to 25 percent in unlisted securities.

Credit risk assessment

SEBI has asked fund houses to conduct an in-house credit risk assessment of debt and money market securities at all points of time. They also need to have adequate provisions for generating early warning signals if there is a deterioration in the credit profile of an issuer.

Al these measures are expected to make debt funds safer for investors.

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