New Sebi norms and impact on investors

The bankruptcy of IL&FS shook the confidence leading to recent liquidity crisis in the Non-Banking Financial Companies (NBFC).

The immediate analysis put the credit agencies in the spotlight on their working and also how the NBFCs have gone about their business of borrowing short-term for their long-term requirements leading to asset liability mismatch.

This has worsened the situation when the larger institution like ILFS has defaulted which had a cascading effect further drying up the liquidity of the other players.

What followed is the default of their loans through various instruments that were to be matured in the coming months majorly funded by the Mutual Funds investing in their various debt funds.

With this backdrop, the regulator Securities Exchange Board of India (SEBI) has come up with further provisions to ensure higher safety of these funds.

The new norms thus largely impact the yields, volatility and increase the costs, particularly with liquid funds making them safer and transparent.

The following are new norms the regulator has instituted for this.

Sebi has mandated for valuations of the debt and money market instruments to be completely based out on the mark-to-market (MTM).

This is a change from the earlier rule of applicability of the amortization method of valuation to debt securities maturing within 30 days.

This is at the backdrop of deregulation in these funds where the Sebi has reduced the applicability of amortization method to only bonds with a residual maturity of up to 91 days in 2010 to 60 days in Feb 2012 and to the current 30 days this year.

This move will not mask any skewed Net Asset Value (NAV) to the investor and project a true picture though it would contribute to increased volatility in these funds.

Liquid funds have to mandatorily hold at least 20 per cent of their funds in liquid assets like cash, Government Securities (G-Sec), Treasury Bills (T-bills) etc.

This is an important regulation where earlier at two instance of time during the Great Financial Crisis (GFC) of 2008 and then during 2013 when the liquidity crunch due to higher redemption led to sale of securities irrespective of their quality.

This move would provide greater liquidity especially during crisis events like the last time but would however have a negative impact on the returns of these funds.

The regulator reduced the sectorial cap on debt funds from the existing 25 per cent to 20 per cent of the entire assets.

Also, has put in restrictions into the exposure to Housing Finance Companies (HFC) with a maximum limit of 10 per cent from the current 15 per cent. Further, MFs are not allowed to have exposure in a particular group to more than 5 per cent.

The curbs on the exposure to structured instruments, credit enhancements, unlisted securities and loan against shares (LAS) is a very good move.

Particularly this kind of imprudent approach to load up such troubled instruments caused defaults and heart burn for the investors in Fixed Maturity Plans (FMP)

Moreover, the regulator has directed to have a security cover of four times of their investments in debt securities having credit enhancements backed by equities.

This move results in bringing better diversification with improved quality of instruments while avoiding concentration risks into one company or its affiliates that happened with the recent ILFS issue.

A very important development happened in the liquid fund category is the introduction of exit load which would be now applicable to funds that are redeemed within 7 days of the investment.

This could make overnight funds appear attractive for ultra-short-term period for the corporates. But this also attracts the right set of investors into these funds alleviating redemption pressure.

Another significant move by the Sebi is to allow MFs to only invest in listed non-convertible debentures (NCD) although in a phased manner.

And further all the fresh investments in commercial paper (CP) have to made only in listed CPs in accordance with the new Sebi guidelines issued in this regard.

Additionally, liquid and overnight funds will not be allowed to invest in short-term deposits, debt and money market instruments having structured obligations or credit enhancement at all.

All these measures bring confidence back to the investors into these funds while helping the investors achieve their goals according to the fund objective.

(The author is a co-founder of "Wealocity", a wealth management firm and could be reached at knk@wealocity.com)