Debt MF schemes: Sebi contemplates stress testing, minimum asset allocation in liquid assets

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September 22, 2020 5:01 PM

According to Sebi chief, this benefits exiting investors at the cost of those who continue to stay particularly in case of stressed situations.

It is advisable to invest via SIP which enables investors to average the cost of his investments. It is advisable to invest via SIP which enables investors to average the cost of his investments.

With an aim to bring liquidity, markets regulator Sebi is mulling stress testing, minimum asset allocation in liquid assets and swing pricing like mechanism for all open-ended debt oriented mutual fund schemes, its chief Ajay Tyagi said on Tuesday.

Sebi is facilitating the setting up of an expert committee to frame a stress testing methodology, encompassing liquidity, credit and market risks, Tyagi said while addressing industry body Association of Mutual Funds in India (Amfi) 25th annual general meeting.

The committee will also design a framework to determine the minimum asset allocation required in liquid assets, taking into account the nature of scheme’s assets, type of investors, outcome of stress testing and minimum redemption requirement during gating, he added.

In the interim, taking into account the recommendations made by the mutual fund advisory committee, Sebi said it would be stipulating a minimum holding of liquid assets by all debt-oriented schemes.

While overnight schemes are primarily invested in liquid assets such as government securities(G-Secs), treasury bills (T-bills), repo in G-Sec and cash, and there is a provision for liquid schemes to hold a minimum 20 per cent in liquid assets.

The other debt-oriented schemes currently have no such requirement and can invest in various categories of corporate bonds, commercial papers, whose secondary markets may not have enough liquidity.

As far as performance of the mutual fund industry is concerned, Tyagi said overall, the industry has weathered the storm well, which demonstrates the robustness of the regulatory framework as well as the maturity of the industry.

The industry, however, also went through several patches of challenges, especially on the debt mutual fund side.

“Some of the issues that arose during the period are now addressed and some are in the process of being addressed,” he noted.

In March-April 2020, significant risk aversion and subsequent illiquidity were observed in the bond market especially in “AA” and below rated papers.

The move created significant challenges in the form of redemption pressures being faced by debt mutual funds, on account of not only normal year-end redemptions, but COVID-19 related redemption pressures.

“…That experience brought to fore not only the structural issues related to the corporate bond markets but also revealed some areas of improvement in respect of the practices followed in the mutual fund industry,” Tyagi said.

Another issue that got highlighted was the possible impact of large redemptions on remaining unitholders of a scheme.

In case of any scheme witnessing large redemption requests, and with not so liquid instruments as assets, there are high chances that more liquid assets get liquidated first and the scheme is then progressively left with a relatively more illiquid portfolio, he said.

According to Sebi chief, this benefits exiting investors at the cost of those who continue to stay particularly in case of stressed situations.

He, further, said the proposed expert committee will also examine liquidity risk management tools such as “swing pricing/anti-dilution levy” for passing on transaction costs to the transacting investors.

The tools will apply to both the incoming and outgoing investors, thereby protecting the interest of existing investors, he added.

Besides, Securities and Exchange Board of India (Sebi) will soon come out with a ‘backstop facility’ for debt mutual funds.

“An entity which can trade in relatively illiquid investment-grade corporate bonds be readily available in times of stress to buy such bonds from various market participants in the secondary market may instil greater confidence of market participants in corporate bonds, especially in below AAA investment grade,” Tyagi said.

Sebi is examining the setting up of such a backstop facility in consultation with various stakeholders.

“Of course, as a broad general guiding principle, for any such entity to be set up, the market participants should have ‘skin in the game’ and the ‘moral hazard’ problem ought to be satisfactorily addressed,” he added.

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