Mutual funds may lose their attractiveness as a preferred source of capital for corporates and non-banking financial companies (NBFCs) as new rules aimed at protecting investors in liquid and debt funds from credit risks take effect.
The rules, which were announced by the Securities and Exchange Board of India (Sebi) on 27 June, may make it tougher for borrowers to strike deals with fund managers to raise capital. While the new set of rules such as graded exit load, higher security for credit enhanced securities, increased capital allocation in liquid assets do not entirely bar lending by mutual funds (MFs), it however makes it extremely complex to close deals for fund managers and promoters, according to industry experts. “As a consequence of this, borrowers may have to seek alternative sources of capital such as alternative investment funds (AIF) and high net-worth individuals (HNI) to raise funds," a chief executive of a non-bank lender said on the condition of anonymity.
MFs have emerged as one of the key sources of funds for non-banks in the past few years, raising concerns about potential asset-liability mismatches of the borrowers. Sebi had referred these concerns late last year to its Mutual Fund Advisory Committee to suggest remedial measures.
Following the committee’s recommendation, Sebi has decided to increase the minimum security cover ratio of credit enhanced securities or structured obligations that also include loan against shares (LAS) to four times from prevalent industry standards of 2:1 with some funds accepting cover ratios of 1.5 to 1.75 times of the exposure “The proposed hike in minimum collateral cover to 4 times for new LAS transactions will most likely move borrowers away from mutual funds," said Dhawal Dalal, chief investment officer of fixed income at Edelweiss Asset Management Co. Additionally, Sebi also capped the exposure to these papers at 10% of the total assets of the fund.
According to data from Value Research, mutual funds had an exposure of ₹11,435 crore to structured obligations. Sebi’s latest regulations aim to create additional buffer and derisk liquid funds further by making it mandatory to keep a minimum 20% of the assets in liquid securities or cash equivalents.
“The additional requirement of parking funds in liquid assets will end up making money market unattractive," said Ajay Magnulia, managing director of JM Finanical.
Starting September 2020, fund houses will be allowed to invest only in listed non-convertible debentures (NCDs) and commercial papers (CPs). Currently, about ₹3-4 trillion are in CPs, which are largely unlisted while ₹25 trillion is invested in NCDs, most of which are listed.
“Going forward, CP issuers may weigh additional cost of listing commercial papers against the possible lower yields of borrowing in the money market from mutual funds. We don’t envisage most of them migrating to banks in large numbers for their working capital funding needs due to this measure," said Dalal of Edelweiss.
“It is not difficult but an additional compliance cost," said Magnulia of JM Financial.
Another major concern for liquid funds is the graded exit load if investors exit before seven days. “The seven-day exit load will impair the competitive advantage of liquid funds against bank FDs," said Mahendra Kumar Jajoo, head of fixed income at Mirae Asset Mutual Fund. Out of ₹25 trillion of assets under management, about ₹5.4 trillion are parked in liquid funds and about 30% is parked for less than seven days. “India is an outlier for suggesting an exit load for seven days. This will badly impact bond market. The restriction will further impair growth prospects liquid fund market," said a fund manager, who declined to be identified.