NCD move may hit liquid funds

Funds may lose an investment option as RBI bans short-term NCDs.

The proposed move by the Reserve Bank of India to ban non-convertible debentures (NCDs) with less than 90 days maturity may see returns of liquid funds and ultra short term funds falling further.

Liquid funds are currently offering close to 5.2 per cent returns. Experts say it may come down to 3-3.5 per cent if the latest RBI move kicks in, as mutual funds will not be able to invest in short-term instruments and will have to invest in CBLO (collaterised borrowing and lending obligation, a type of derivative debt) and repo (repurchase agreement, a form of short-term borrowing), negatively impacting their returns.

Liquid fund returns have already gone down with the recent Sebi guideline mandating that liquid funds can no longer invest in papers of more than 91 days’ tenure. Annualised returns for liquid funds have fallen from 7.85 per cent a year before to 5.2 per cent now. The approximate total size of Mibor-linked NCDs subscribed by various mutual fund schemes is expected to be Rs 6, 000 crore.

“For mutual funds, a large window for investments at the shorter end will close and efficient daily cash management will be only restricted to CBLO and repo routes. It is quite possible that exit loads might come up even in cash management schemes of mutual funds for some periods like 7 days, 15 days, as a deterrent to protect large outflows,” said Deepak Sharma, CEO of Sarthi Wealth Management Consultants.

The RBI proposal emanates from the need to regulate short-term NCDs. Recently, the Reserve Bank of India governor expressed his concern about the sharp increase in banks’ investment in mutual funds. Banks have been parking in excess of Rs 1 lakh crore in debt funds in the past few months, which sometimes circulates from mutual funds back to banks.

The way it works is: A company issues a short term NCD at Mibor+100 or 50, which is subscribed by the liquid scheme of a mutual fund. The corporation uses this money to repay cash credits and bank overdraft limits, as the rates offered by mutual funds are much cheaper compared to banks. The bank, in turn, again invests this money into mutual funds under their treasury management operations. The same money is used by mutual funds to lend to corporates.

RBI has been wary about circularity of funds and mutual funds acting as quasi-banks. The reason being, credit offtake is not happening. Corporates are not approaching banks for money; rather, they are going to mutual funds. “The short-term CP and CD market will get very active. Currently, CPs and CDs are not very liquid instruments, so to say, which might also mean mutual funds taking a liquidity risk and asset liability mismatch. What we ideally need is a vibrant short-term corporate bond market. Going ahead, there will be more demand for floating rate instruments”, said Devendra Nevgi, an independent investment consultant.

The other implications of the proposed move might also be in the funding cost of companies going up. Since daily borrowing options may close for them, they need to plan their cash flows much more efficiently and may borrow a little excess, which will lead to additional cost of borrowings. IPO Financing might also get affected, since most NBFCs build the book through borrowings from short-term NCDs, with put and call option of less than 90 days.