SEBI Tightens Risk Management Framework Of Liquid Funds And Prudential Norms Governing Investments In Debt Instruments

The Securities and Exchange Board of India (SEBI) has come up with a Review of Risk Management Framework of Liquid Funds, Investment Norms and Valuation of Money Market and Debt Securities by Mutual Fund. It noted that in light of a few credit events in the fixed income market that led to increase in liquidity risk of Mutual Funds, a need was felt to review the regulatory framework and take necessary steps to safeguard the interest of investors and maintain the orderliness and robustness of Mutual Funds. In this context, SEBI had constituted working groups representing AMCs, industry and academia to review the risk management framework with respect to liquid schemes and to review the existing practices on valuation of money market and debt securities.

 

Further, an internal working group within SEBI was constituted to inter-alia review norms for Mutual Funds for investment in various debt and money market securities. The analysis along with recommendations of the working groups were placed in a meeting of Mutual Fund Advisory Committee (MFAC). In this regard, MFAC made several recommendations. The Board after deliberations, inter-alia, approved the following proposals: Risk Management Framework of Liquid Funds and prudential norms governing investments in debt and money market instruments.Liquid Schemes shall be mandated to hold at least 20% in liquid assets such as Cash, Government Securities, T-bills and Repo on Government Securities.

The cap on sectoral limit of 25% shall be reduced to 20%. The additional exposure of 15% to HFCs shall be restructured to 10% in HFCs and 5% exposure in securitized debt based on retail housing loan and affordable housing loan portfolios.The valuation of debt and money market instruments based on amortization shall be dispensed with completely and shall be based on mark to market.

Liquid and overnight schemes shall not be permitted to invest in Short Term Deposits, debt and money market instruments having structured obligations or credit enhancements. A graded exit load shall be levied on investors of liquid schemes who exit the scheme upto a period of 7 days. Mutual Fund schemes shall be mandated to invest only in listed NCDs and the same would be implemented in a phased manner. All fresh investments in Commercial Papers (CPs) shall be made only in listed CPs pursuant to issuance of guidelines by SEBI in this regard. All fresh investments in equity shares by Mutual Fund schemes shall only be made in listed or to be listed equity shares. Prudential limits on total investment by a Mutual Fund scheme in debt and money market instruments having credit enhancements and on investment by Mutual Fund scheme in such debt securities of a particular group, as percentage of debt portfolio of the respective scheme have been prescribed at 10% and 5% respectively. There should be adequate security cover of at least 4 times for investment by Mutual Fund schemes in debt securities having credit enhancements backed by equities directly or indirectly.

In order to make existing provisions on valuation of money market and debt securities more reflective of best practices, various proposals for amending the extant provisions were approved. Further, in order to bring uniformity and consistency in valuation, various proposals on the waterfall approach for valuation of non-traded money market and debt securities by Mutual Funds were approved, along with acknowledging that valuation agencies may need a certain degree of flexibility in order to ensure fair pricing of securities.

Nevertheless, in terms of the Principles of Fair Valuation, AMCs are responsible for ensuring fairness of valuation and they may deviate from the valuation guidelines, subject to appropriate documentation and disclosure. In order to increase the robustness of valuation and address possible misuse, various proposals related to valuation of Inter-scheme Transfers (ISTs), disallowing the use of own trades for valuation etc, were approved.

Suitable grandfathering wherever applicable and adequate time period shall be provided for implementation of the above proposals. The Board considered representations received from the market on certain aspects relating to Code of Conduct prescribed in the SEBI (Prohibition of Insider Trading) Regulations, 2015 (PIT Regulations). Upon consideration, the Board approved amendments clarifying that trading window closure for listed companies shall be applicable from end of every quarter till 48 hours after declaration of financial results.

The amendments clarify that such closure shall not be applicable in respect of transactions such as off-market inter-se transfer between insiders, transaction through block deal window mechanism between insiders, transaction due to statutory or regulatory obligations, exercising of stock options, pledging of shares for bona fide transaction such as raising of funds and transactions for acquiring shares under further public issue, right issue and preferential issue, exercising conversion of warrants / debentures, tendering shares under buy-back, open offer and delisting etc. under respective regulations, subject to conditions specified. The Board also approved amendments clarifying material financial relationships.

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