SEBI Board Meeting: SEBI Imposes Curbs On Mutual Funds’ Investments In Debt Securities

• Mutual funds will have to mark to market their investments in debt and money-market instruments. The regulator dispensed with valuations based on amortisation.
• Mutual funds can only have 20 percent exposure to one sector in a scheme, down from 25 percent earlier.
• SEBI mandated liquid funds to hold 20 percent holdings in liquid assets.
• SEBI has levied a graded exit load on investors of liquid schemes who redeem with seven days of making an investment.
• Chairman Ajay Tyagi said the regulator does not recognise the standstill agreements entered into by mutual funds with companies.

Other Decisions

• SEBI’s board also approved a framework for issuance of DVR shares.
• The regulator has mandated that promoters will now have to disclose the reason for encumbrance of pledged shares whenever it crosses 20 percent of the total share capital.
• SEBI has also amended royalty norms. If the royalty payments cross 5 percent of annual turnover, then the company must get shareholder approval.

Watch Tyagi’s Press Conference Here:

The Securities and Exchange Board of India has approved stricter norms on investments by mutual funds, after a spate of credit-related events have put investor money at risk.

Mutual fund schemes will now be mandated to invest in only listed non-convertible debentures. All fresh investments by mutual funds in commercial papers and equities will also be allowed only in listed securities.

Moreoever, the way mutual funds value debt and money market instruments will also be changed. Now, the valuation will be made on a mark-to-market basis, compared to the amortisation basis done earlier. Mutual funds will also have to provide adequate cover—at least four times—for their investments in debt, which has to be backed by equities directly or indirectly.

Concerns about the mutual fund industry's exposure to corporate debt has led to fund flows declining. The concerns about debt investments started in September last year when mutual funds wrote off investments in IL&FS Group. Standstill agreements with Essel and Anil Ambani groups and the troubles of Dewan Housing Finance Corporation Ltd. only added to the worries.

SEBI Chairman Ajay Tyagi said that the decisions have been taken after wide consultations with the mutual fund industry, which is on board with the amendments. Tyagi said these decisions will help address the stress created by the crisis in the non-banking lenders.

SEBI has also made an amendment to its royalty payment norms. If the royalty payments cross 5 percent of annual turnover, then it shall require shareholders' approval.

The chairman said that the regulator does not recognise any standstill agreement between promoters and mutual funds. “Mutual funds are not banks, so there's nothing called standstill. There are investing, not lending.”

Tyagi said that restrictions have been introduced in consultation with the industry to bring in more discipline and protect investors' money.

Tyagi said the regulator has taken a cautious approach with differential voting rights in shares. This is the first time this is being tried in India, he said.

There’s also a counter argument that corporate governance needs to be tightened, Tyagi noted, adding that SEBI has tried to address those concerns.

Tyagi said that the reglator has had wide consultations with the mutual fund industry about amending rules for valuation of debt securities. The industry is on-board with the amendments, he said.

Investments by mutual funds are different from lending by banks and they need to balance safety and investment. Such investments have to be prudent, Tyagi said.

SEBI had constituted a working group to review its risk management framework for mutual fund schemes, in light of credit events in fixed income market that led to a increase in liquidity risk of mutual funds.

The regulator has approved the following proposals:

• Liquid schemes will be mandated to hold at least 20 percent in liquid assets like cash, government securities and treasury bills.
• The cap on sectoral limit has been reduced to 20 percent from 25 percent earlier.
• The valuation of debt and money market instruments based on amortisation will be dispensed with completely and now be on mark-to-market value.
• Liquid and overnight schemes will not be permitted in short term deposits, debt or money market instruments having structured obligations.
• Mutual fund schemes will be mandated to invest only in listed non-convertible debentures. All fresh investments in commercial papers will be made only in listed ones.
• All fresh investments in equity by mutual fund schemes will be only made in listed or to be listed shares.
• Investment by mutual fund schemes in debt and money market instrument with credit enhancement capped at 10 percent of the debt portfolio. Investment in debt securities of a particular group capped at 5 percent of the debt portfolio.
• Mutual funds will be required to have a security cover of at least 4 times their investment in debt, which has to be backed by equities directly or indirectly.

The definition of encumbrance has been broadened, said SEBI Chairman Ajay Tyagi.

Promoters will have to disclose the reason for encumbrance whenever their combined encumbrance crosses 20 percent of the total share capital or 50 percent of their shareholding, he explained.

The board of the Securities and Exchange Board of India is meeting today to decide on a variety of issues from clarifying norms on differential voting rights in shares to tightening disclosure norms for shares that are considered for pledging.

Tightening encumbrance disclosure by promoters of listed firms is on the agenda today with a growing number of cases in which share value declined sharply after defaults, with lenders scrambling to sell pledged shares.

The regulator already has a set of regulations for encumbrance disclosure. Yet, concerns have been raised recently with mutual funds’ exposure to debt and money market instruments through structured obligations, pledge of shares, non-disposal undertakings, related party transactions or promoter guarantees.

According to Crisil, the total value of shares pledged by promoters is more than Rs 2 lakh crore, involving over 800 companies. Moreover, this data is only for loans against pledged shares and doesn't include other encumbrances such as non-disposal undertakings.

This has implications for the lending community, for such debt is backed by equity shares that are inherently volatile as against cash flows.

The regulator is also likely to clarify buyback rules. Existing regulations require consideration of consolidated financials for a buyback. This had led to to the regulator rejecting Larsen & Toubro Ltd.’s buyback proposal.

In addition, the regulator had deferred implementation of regulation with respect to royalty payments by companies to July 1. The regulator is likely to clarify its stand on this issue.