The credit crisis in 2018 created a serious dent in investor confidence in the debt markets in India. Their confidence was further bruised by Franklin Templeton’s decision to wind up its 6 debt schemes in April 2020.
To protect the investors and regain their confidence, market regulator, Securities, and Exchange Board of India (Sebi) has introduced several reforms in the functioning of the debt mutual funds aimed at reducing market volatility, enhancing liquidity, and improving overall transparency of the industry. Notable among these are:
Holding structure in Liquid Schemes: Liquid Funds now need to hold a minimum of 20 per cent of their Assets Under Management (AUM) in liquid assets such as cash, government securities, T-bills, and repo on government securities. This will help provide a cushion to AMCs in case of heightened redemption pressures arising in the future and mitigate liquidity risk for investors.
Investment restrictions: Liquid and overnight schemes are no longer allowed to invest in instruments having structured obligations or credit enhancements. As far as other schemes are concerned, the limit has been capped at 10 per cent. Further, credit enhancements backed by equity shares directly or indirectly should have a minimum cover of four times the market value of such shares. These will protect investors from any kind of default risk associated with such high yield bonds. The cap on the sectoral limit has been brought down from 25 per cent to 20 per cent, while exposure to a single group cannot exceed 5 per cent.
Disclosure of portfolio: To bring transparency, all debt schemes have to disclose their portfolio holdings on a fortnightly basis instead of a monthly basis, from October 1, 2020. Further, AMCs will have to declare the yield at which each security in the portfolio is valued along with the overall portfolio yield.
RFQ platform: At least 10 per cent of a mutual fund’s total secondary market trades in corporate bonds are now to be done by placing quotes through the Request For Quote (RFQ) platform. All transactions wherein mutual funds are counterparties of the trade will need to be executed through the RFQ platform of stock exchanges in one-to-one / one-to-many modes. The platform unlike OTC will allow market participants to transact in debt securities by requesting quotes from several participants simultaneously, thereby creating better price discovery.
No Inter-Scheme Transfers: From January 2021, no Inter-Scheme Transfers (ISTs) in close-ended funds will be allowed after three business days of the allotment of units to investors. For open-ended funds, AMCs may consider ISTs only if they are unable to raise liquidity through all other avenues available, such as using cash and cash equivalents, market borrowings, and selling securities in the market. The purpose is to prevent misuse of this facility through the transfer of illiquid securities to other schemes.
Stringency norms for AT-1 bond issues: The Yes Bank fiasco has led SEBI to bring out stricter regulations for fresh issues of Additional Tier-1 bonds. This is aimed at protecting retail investors from the rampant misselling that has occurred in the past. These bonds can now only be subscribed to by qualified institutional buyers only for a minimum allotment of Rs 1 crore.
Revamped Risk-o-Meter: The revamped mutual fund Risk-o-Meter brings in 6 levels of risk vis-a-vis the 5 that existed earlier. An additional ‘Very High’ risk category has been introduced and detailed guidelines have been provided to assess the risk level of each fund. The risk level is to be recalculated every month and the mutual fund schemes will now have to publish the history of risk-o-meter changes at a scheme level every year. This creates transparency on the changing risk profile and gives a precise assessment of risk while investing.
Apart from the above, several other measures such as side-pocketing of funds, valuation of securities on a mark-to-market basis and better internal credit risk assessment methods have been introduced to strengthen the debt mutual fund industry. Furthermore, Sebi is also contemplating the introduction of a repo market in corporate bonds and a backstop facility to facilitate liquidity in the corporate bond market, especially in below AAA-rated investment-grade bonds. All these measures are positive for investors and in the long term will act as a fillip to the growth of Indian capital markets.
The author is Head of Investment Advisers, HDFC Securities