SEBI Finalises Draft For Mutual Funds To Invest Only In Listed Securities
A passenger sits below an advertisement for the Mutual Funds Sahi Hai campaign by the Association of Mutual Funds in India (AMFI) at a bus stop in Mumbai, Maharashtra, India. (Photographer: Dhiraj Singh/Bloomberg)

SEBI Finalises Draft For Mutual Funds To Invest Only In Listed Securities

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With the aim to safeguard mutual fund investors from high-risk assets, the Securities and Exchange Board of India wants fund houses to shift all their investments to listed or to-be-listed equity and debt securities in a phased manner.

It also wants them to reduce their exposure to unrated debt instruments from 25 percent to only 5 percent.

Exposure to risky debt securities has emerged as a major risk for the capital market investors, including those coming through the mutual fund space, and the regulator has been making efforts to enhance its regulatory safety net against such risks.

Taking forward certain decisions approved by the SEBI’s board earlier in June, the regulator has now finalised the draft amendments to the prudential norms for mutual fund schemes for investment in debt and money market instruments.

Besides, some further amendments have been proposed for approval of the regulator’s board at its next meeting later this month, officials said.

A key fresh proposal is to reduce the existing overall limit for investment of mutual fund schemes in unrated debt instruments, except those for which specific norms are separately provided, from 25 percent to 5 percent.

Further, the existing provision of the single issuer limit of 10 percent for investment in unrated debt instruments has been proposed to be dispensed with, an official said.

However, the official said these proposed limits may need to be reviewed periodically by the market watchdog after taking into account the market dynamics and participation of mutual funds in unrated debt securities from time to time.

Among other decisions which have been in-principle already approved by the SEBI board and need to be incorporated in the amended regulations, the valuation of debt and money market instruments based on amortisation would be dispensed with and would shift completely to mark-to-market valuation with effect from April 1, 2020.

Also, mutual funds would be permitted to accept upfront fees with disclosure of all such fees to valuation agencies and standard methodology for treatment of such fees would be issued by the industry body Association of Mutual Funds in India in consultation with the SEBI.

Under the new proposed prudential framework, mutual funds would invest only in listed or to-be-listed equity shares and debt securities (including commercial papers) and this would be implemented in a phased manner.

SEBI would soon issue a circular on operational aspects of the proposal such as timelines, grandfathering of existing investments, exclusion of exposure in debt instruments such as interest rate swaps, etc.

The existing regulations allow a mutual fund scheme to invest a maximum of 10 percent of its net asset value in unrated debt instruments issued by a single issuer while the total investment in such instruments is capped at 25 percent.

However, pursuant to SEBI’s decision to allow mutual funds to invest only in listed securities, very limited number of instruments that are unrated would be eligible for investment by the mutual funds, as all listed debt instruments are mandatorily rated.

After excluding debentures, government securities, interest rate swaps, interest rate futures, repo on G-Sec and T-bills, the mutual funds' investments in unrated debt instruments are mostly in fixed deposits, bills re-discounting (BRDS), mutual fund units, repo on corporate bonds, units of REITs/InvITs (Real Estate and Infrastructure Investment Trusts), etc.

However, the SEBI has already has separate investment norms for fixed deposits, mutual fund units, repo of corporate bonds and REITs/InvITs and the exposure to these instruments does not form part of the existing 25 percent investment cap.

Excluding all these instruments, the total exposure of mutual funds in the remaining unrated debt instruments is mostly in BRDS, amounting to about Rs 2,870 crore as on March 31, 2019.

Besides, this investment is limited to just four mutual fund schemes and the average value of investments as percentage of the respective scheme's asset under management was just about 3 percent.

As a result, the SEBI is of the view that the existing limit of 25 percent for investment in unrated debt instruments would be too high as the residual investment permitted in this category might be relevant only for few instruments including BRDS.

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