A key 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 per cent to 5 per cent.
With an aim to safeguard mutual fund investors from high-risk assets, regulator Sebi wants fund houses to shift all their investments to listed or to-be-listed equity and debt securities in a phased manner and reduce their exposure to unrated debt instruments from 25 per cent to 5 per cent. After a meeting of its board here on Wednesday, Sebi said it has also decided to give flexibility to mutual funds to invest in unlisted non-convertible debentures (NCDs) up to a maximum of 10 per cent of the debt portfolio of the scheme. This would be subject to such investments in unlisted NCDs having simple structures, being rated, secured and with monthly coupons. This would be implemented in a phased manner by June 2020.
Exposure to risky debt securities has emerged as a major risk for capital market investors, including those coming through the mutual fund route, and the regulator has been making efforts to enhance its regulatory safety net against such risks. Taking forward certain decisions approved by 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. Some further amendments were also approved by Sebi’s board at its meeting held here on Wednesday.
A key 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 per cent to 5 per cent. Further, the existing provision of the single issuer limit of 10 per cent 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 Sebi after taking into account the market dynamics and participation of mutual funds in unrated debt securities.
Among other decisions which have in-principle already been 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 industry body AMFI (Association of Mutual Funds in India) in consultation with 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 and exclusion of exposure to debt instruments such as interest rate swaps.
The existing regulations allow a mutual fund scheme to invest a maximum of 10 per cent 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 per cent. 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 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 and units of REITs/InvITs (Real Estate and Infrastructure Investment Trusts). However, Sebi already has separate investment norms for fixed deposits (FDs), mutual fund units, repo of corporate bonds and REITs/InvITs and the exposure to these instruments does not form part of the existing 25 per cent investment cap.
Excluding all these instruments, total exposure of mutual funds to 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 per cent. As a result, Sebi is of the view that the existing limit of 25 per cent 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.