IL&FS effect: Sebi may review existing regulatory norms for liquid schemes

The liquidity squeeze triggered by the Infrastructure Leasing & Financial Services (IL&FS) default has prompted the Securities and Exchange Board of India (Sebi) to review the existing regulatory framework for liquid schemes. 

The market regulator is considering new measures that will help these schemes manage liquidity and risks better, said industry sources. Among the suggested changes, Sebi could reduce the single-investor limit in liquid schemes, restrict the flow of “hot” money in such schemes, and direct such schemes to have larger liquidity buffers in tough markets. 

At present, the single-investor investment limit is pegged at 25 per cent of a scheme’s corpus. To improve the liability profile of the liquid schemes, the regulator plans to bring down the single-investor limit. Experts say few large investors accounting for a bulk of a scheme’s corpus pose a concentration risk in liquid schemes. 

“The 20-25 rule is not good enough. It is too liberal. There needs to be a wider ownership of the schemes,” said Dhirendra Kumar, founder of Value Research. The current regulations state that a fund needs to have at least 20 investors and no single investor can account for more than 25 per cent of the fund’s corpus. 

Besides reviewing the single-investor limit, the regulator is mulling whether a liquid scheme is the right place for money meant for banks’ intra-day liquidity. 

Sources said the regulator doesn’t want money chasing arbitrage opportunities to be parked in liquid schemes.

One of the proposals being mooted is that only money meant for more than seven days should be allowed in liquid schemes. Money meant for less than seven days can be directed towards overnight instruments such as collaterized borrowing and lending obligation (CBLO).  

Introducing more safeguards in liquid schemes can help the industry, as the volatile nature of the flows hurts profitability of fund houses. “To manage the daily redemptions in the liquid schemes, fund houses at times need to borrow from banks. The cost of financing these redemptions impacts the margins of the asset management companies,” said an industry official.

Recently, investors pulled out a large chunk of funds parked in liquid schemes amid fears of contagion risks from the IL&FS crisis.  

The multi-notch downgrade of IL&FS in September, which was considered quasi-sovereign, led to a sharp spike in yields. The AAA-rated papers of non-banking financial companies, where fund houses have large debt exposures, started to see a 50-70 basis points spike in yields as liquidity dried up.

The net outflow from liquid schemes in September was Rs 2.1 trillion, which accounted for 8 per cent of the industry’s assets under management. While the industry was anticipating sizeable outflows for advance tax payments, the large quantum was surprising. 

As selling debt papers in corporate bond market became difficult, fund houses’ ability to meet redemption requests was challenged. Some fund houses looked at borrowing from banks to deal with the crunch, said sources.  

Sources say the regulator may come out with a mechanism in which schemes can generate their own liquidity with a higher exposure to treasury bills and CBLO instruments. “In tough markets, even high-rated papers lack liquidity. It is important that liquid schemes have enough buffers to deal with liquidity risks,” said a source privy to the development.