The Securities and Exchange Board of India (SEBI) chairman Ajay Tyagi stated on September 22 that the regulator wanted to bring in more changes to improve risk-management of debt mutual fund (MF) schemes, including stipulating minimum investment to liquid assets for all the open-ended debt schemes.
“While overnight schemes are primarily invested in liquid assets and there is a provision for liquid schemes to hold a minimum 20 percent in liquid assets, there is no such requirement for other debt-oriented schemes,” Tyagi pointed out.
The SEBI chairman was speaking at the 25th annual general meeting of the Association of Mutual Funds in India (AMFI).
The regulator is facilitating the setting up of an expert committee to frame a stress-testing methodology, encompassing liquidity, credit and market risk for all open-end debt-oriented mutual fund schemes.
This committee will be tasked with designing a framework to determine minimum asset allocation required in liquid assets, taking into account the nature of schemes, assets, types of investors, outcome of stress-testing, minimum redemption requirement during gating, etcetera.
Tyagi said that, in the interim, SEBI would be stipulating minimum holding of liquid assets by all debt-oriented schemes, taking into account recommendations of Mutual Fund Advisory Committee (MFAC).
The SEBI chairman said that some of the structural issues were brought to the fore by significant risk aversion and subsequent illiquidity that was observed in the bond market, especially in AA and below rated papers earlier in the year. There were also significant challenges in the form of redemption pressures faced by debt mutual funds, both on account of Covid-related redemptions and normal year-end redemptions.
Measures to protect interests of remaining investors during redemptions
SEBI chairman said that another issue that has come to light is the possible impact of large redemption on the remaining unitholders of a debt scheme. In case of any scheme witnessing large redemptions and not adequate liquid assets, there are higher chances that more liquid assets get liquidated first and scheme is then progressively left with a relatively illiquid portfolio.
This benefits exiting investors at the cost of those who stay, especially in stressed situations.
The proposed expert committee will also examine liquidity risk-management tools, including passing transaction costs to transacting investors. The tools would apply to both incoming and outgoing investors, to protect interests of remaining investors.
Examining setting-up of a backstop facility
SEBI is examining the setting up of a backstop facility. This would entail setting up of an entity which can trade in relatively illiquid investment grade corporate bonds and be readily available in times of stress to buy such bonds from various market participants in the secondary market. Tyagi said such an entity could instill greater confidence of market participants in the corporate bonds, especially in below AAA-investment grade. Tyagi said that as a broad guiding principle, for any such entity the market participants should have ‘skin in the game’ and the ‘moral hazard’ problem needs to be satisfactorily addressed.
“If this move is implemented it could be a game-changer for the corporate bond market and lead to improvement in liquidity. However, we would need to see how the issue of ‘moral hazard’ is properly addressed,” said Dwijendra Srivastava, chief investment officer-debt at Sundaram Mutual Fund.
Moral hazard would entail any ‘conflicts of interest’ in the event the backstop entity is favouring a stressed corporate and the interests of the debt scheme unitholders are compromised.
Examining representations of industry on multi-caps
On question of introducing a ‘flexicap’ category or a new benchmark for multi-cap schemes, as the combined weightage of the benchmark NSE 500 to mid- and small-caps was about 19 per cent, Tyagi said that the regulator’s stance has been that the products should be true-to-label.
“First of all, the form of the scheme should be as per the name and then the benchmark should be identified. We are not forcing anyone to invest in those caps. Investments should be done in the best interests of investors. The form should be as per the same name. We have received representation from AMFI, we are seeing how to further clarify this. The intention should not be to push investments, which are not in the best interests of the investors,” he said.
The latest proposed minimum limits stipulated by SEBI for multi-cap schemes require 25 per cent allocation each to mid- and small-cap stocks.
Difference between ‘investing’ and ‘lending’
Tyagi said that debt mutual funds must remember at all times that there is a difference between ‘investing’ and ‘lending’. He said that mutual funds are not banks and should not attempt to behave like one. "Unlike banks there are neither capital adequacy requirements for mutual funds nor do they have the ‘lender of last resort’ comfort as banks have from Reserve Bank of India. The true reflection of their portfolio in its NAV on a daily basis is the cornerstone of transparency and investors’ trust," he said.
On improving corporate bond liquidity
Tyagi pointed out some of the measures taken by SEBI to improve liquidity for corporate bonds. He said that SEBI had mandated that at least ten per cent of mutual Fund’s total secondary market trades in corporate bonds need to be done by placing quotes through one-to-many mode on the Request for Quote (RFQ) platform of stock exchanges. Further, all transactions in corporate bonds and commercial papers where in mutual funds are on both sides of the trade shall be executed through the RFQ platform of stock exchanges in one-to-one/one-to-many mode.
