MC EXPLAINER How liquid and overnight funds can now help IAs and RAs meet SEBI deposit norms

SEBI's rationale for allowing liquid and overnight funds stems from their inherent features of high liquidity, stability, and integration within the securities market ecosystem.

The Securities and Exchange Board of India (SEBI) at its June 18 board meeting announced it had approved a proposal permitting investment advisers (IAs) and research analysts (RAs) registered with it to use units of liquid mutual funds and overnight funds, marked with a lien in SEBI’s favour, to meet their mandatory deposit requirements. This offers an alternative to the existing norm of maintaining a bank fixed deposit (FD).

What did SEBI suggest in its consultation paper earlier this year?
On January 14, SEBI released a consultation paper to seek public feedback on a proposal aimed at easing compliance requirements for IAs and RAs. As per the current rules, IAs and RAs must maintain an FD with a lien marked in favour of their respective supervisory bodies—IAASB or RAASB. This deposit is meant to cover any unpaid dues arising from dispute resolution proceedings. Many in the industry have reported difficulties in fulfilling the original requirements., so SEBI had proposed allowing IAs and RAs to use liquid mutual fund units instead of fixed deposits to meet the deposit requirement.

The revised framework was introduced earlier this year. As per that, RAs must maintain a minimum deposit starting from Rs 1 lakh for up to 150 clients, scaling up to Rs 10 lakh for over 1,000 clients, with a similar structure for IAs. These deposits must be maintained on a continuous basis, with compliance deadlines set as April 30, 2025, for RAs and June 30, 2025, for IAs.

What were the industry concerns?

RAs and IAs had pointed out challenges due to inconsistent procedures across different banks and branches, delays in issuing lien documents, lack of awareness among bank staff about SEBI's rules and limited flexibility in interest payout options.

What has SEBI said in its June 18 board meeting?

The SEBI board has approved an amendment allowing RAs and IAs to use overnight funds (along with liquid funds) as a compliant form of deposit to meet their regulatory obligations. This offers a flexible, low-risk alternative to fixed deposits.

What are liquid and overnight mutual funds?
Liquid funds are a type of debt-oriented mutual funds that invest primarily in short-term money market instruments, such as treasury bills, commercial papers and certificates of deposit. These instruments typically have a residual maturity of up to 91 days. The core objective of liquid funds is to offer investors a safe avenue for parking their surplus money while ensuring easy liquidity and moderately better returns than conventional savings bank accounts. Due to the nature of their underlying assets, liquid funds tend to exhibit minimal volatility and carry relatively low credit and interest rate risk.

Overnight funds are "ultra-safe" debt mutual funds that invest in one-day maturity instruments. They offer high liquidity, minimal risk and stable returns.

What is SEBI's rationale behind this decision?

Liquid funds serve as a reliable instrument for managing short-term cash needs or for parking idle funds with the aim of earning modest returns without compromising on liquidity. The structure of these funds allows for quick redemption, often on the same day or the next business day, making them suitable for short-term financial planning and contingency purposes.

SEBI's rationale for allowing liquid and overnight funds stems from their inherent features of high liquidity, stability and integration with the securities market ecosystem. Moreover, the lien on such mutual fund units can be digitally managed, and the control over these instruments remains within the regulatory purview of SEBI itself, enhancing procedural efficiency. The regulator has also noted that mutual fund folios can be easily opened and operated online through asset management company websites and digital platforms.

For RAs and IAs, this development implies more flexibility in fulfilling regulatory obligations. It enables them to deploy capital in instruments that are market-linked yet conservative in risk.

How will the value of mutual fund units be calculated and monitored?

The consultation paper had noted that the value of the liquid mutual fund units will be assessed based on their net asset value, with deductions made for any exit load and a haircut (to account for market risk). This net amount will be considered as the effective deposit. SEBI has proposed that this value be reviewed annually. If the mutual fund units fall below the required deposit amount either due to a drop in value or an increase in the number of clients, the IA or RA must top up the shortfall by lien-marking additional units.

Can this benefit flow into overnight and liquid flows? 

Some experts believe that this move is likely to meaningfully redirect fund flows into these categories. In a conversation with Moneycontrol, veteran market expert Sunil Subramaniam noted that this move aligns with SEBI’s intent to channel money into lower-risk, highly liquid instruments, especially overnight funds, which carry even less risk than regular liquid funds. The shift, he believes, is a boost for the overnight funds segment, helping the industry diversify and enhancing the transmission of the Reserve Bank of India’s liquidity measures, since these funds are tightly linked to short-term interest rate movements, like the repo rate. After seeing inflows of Rs 23,000 crore and Rs 1.18 lakh crore, respectively, in April, liquid  and overnight funds saw outflows of Rs 8,120 crore and Rs 40,204 crore, respectively, in May 2025.