Ajay Tyagi, chairman of Sebi, said while making an investment, the AMC must take into account their mandate and organizational structure (Photo: PTI)
Ajay Tyagi, chairman of Sebi, said while making an investment, the AMC must take into account their mandate and organizational structure (Photo: PTI)

Sebi may tighten asset valuation norms for mutual funds

  • Events in the last year exposed the fault lines in the industry and showed that a credit event in even one issuer could lead to liquidity risk across the market, said Sebi chairman
  • A number of high-profile credit default cases including at IL&FS and DHFL groups have led to MFs bearing huge losses

Mumbai: Market regulator Securities and Exchange Board of India (Sebi) hinted on Tuesday that it may tighten existing asset valuation norms, which guide mutual fund investments to shield investors from risks of capital erosion in debt-oriented mutual funds and to protect asset management companies (AMCs) from unwarranted redemption pressure.

In a meeting between Sebi and the MF industry body Association of Mutual Funds in India or Amfi, Sebi chairman Ajay Tyagi said, “Sebi has reviewed the existing valuation provisions to make them more reflective of the realizable value, to bring in uniformity and consistency in approach, increase robustness of the process and address possible loopholes and misuse of the provisions."

Mutual funds currently have at least Rs. 24.5 trillion of assets under management (AUM) with around 850 million investor folios.

“Based on the review, it has been decided to take certain measures including those relating to the waterfall approach for valuation of non-traded money market and debt securities, flexibility for valuation agencies to ensure fair pricing of securities while continuing to have the final responsibility on the AMC for fair valuation, norms relating to valuation of inter-scheme transfers, disallowing the use of own trades for valuation, etc.," said Tyagi.

Over the past year, credit defaults by several entities had an adverse impact across the financial sector, including mutual funds.

Tyagi said the events in the last one year, exposed the fault lines in the industry and showed that a credit event in even one issuer could have a contagion effect leading to liquidity risk across the market.

According to a Sebi study of liquid schemes, in 20% of the instances over the last year, the average holding in liquid instruments was less than 5% of AUM as compared to an average net redemption in these schemes of around 19%. A certain element of self-discipline by the industry could have averted such a situation, said Tyagi.

“These defaults led to a cascading effect with significant redemption pressures in debt mutual fund schemes, more so in liquid schemes. Within just two months, September and October 2018, the AUM of all debt-oriented schemes as a whole fell by 18% and that of money market schemes fell even more, by 25%. This was despite the fact that the total exposure of all mutual funds schemes to the stressed securities was only around 1% of the total AUM of all debt oriented schemes," Tyagi said while addressing the Amfi meet.

“While it has been around a year since the defaults started, the AUM of open ended debt schemes is yet to reach the AUM levels seen at the end of August 2018. Such instances do not reflect well on the industry practices," added Tyagi.

Tyagi said the events led Sebi to undertake a review of the risk management framework of debt funds, especially liquid funds, and prudential norms governing investments in debt and money market instruments.

Following this, Sebi lowered the cap of overall sectoral limits; minimum holding of 20% in liquid instruments by liquid schemes; restrictions on investments in debt instruments with structured obligations and credit enhancements; dispensing of valuation of debt and money market instruments based on amortization; provision for graded exit load in liquid schemes; and restriction on investments in unlisted equities, NCDs and CPs.

Tyagi said while making an investment, the AMC must take into account their mandate and organizational structure.

“Mutual Funds do not have risk capital and are essentially pass through vehicles wherein NAV ought to reflect the correct value of assets held at any time. This is an important aspect which Mutual Funds should keep in mind while making debt investments," added Tyagi.

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