SEBI tightens rules for MF investment in debt instruments

All of us have witnessed the credit events that are happening these days, where some of the companies are defaulting on their interest payments. Even SEBI (Securities and Exchange Board of India) had addressed this issue and had allowed mutual funds to side pocket the stressed assets. However, they kept the decision of side pocketing on the fund houses. This is where it created a loophole. Despite the facility of side pocketing, only few fund houses like Tata Mutual Fund used this to protect their investors’ interest. So, to further protect the interest of investors, SEBI vide circular SEBI/HO/IMD/DF2/CIR/P/2019/104 dated October 01, 2019 came up with certain regulations with regards to investments in debt and money market instruments. Following are some of the key points.

Investment in listed and unrated instruments
In order to enhance the transparency and disclosure of investment in debt and money market instruments by mutual funds, they now cannot invest in unlisted debt instruments like commercial papers. Government securities and other money market instruments are exception to this. Even the products which are used by the mutual funds for hedging purpose like interest rate swaps, interest rate futures, etc. also form the part of exceptions list. Said that, mutual funds are, however, allowed to invest in unlisted NCDs (Non-Convertible Debentures). Such investments must not exceed 10 per cent of the overall debt portfolio of the scheme. Although, there is one condition to this - the mutual funds can only invest in NCDs with simple structure. This means that the NCDs must be with fixed and uniform coupon, fixed maturity period, without any options, fully paid up upfront, without any credit enhancements or structured obligations. Also, they must be rated and secured with coupon payment frequency on monthly basis. Although, existing investments in unlisted instruments can be continued till maturity, extension of maturity, rolling over of existing investments and fresh investments should adhere to the stated regulation. Investment in unrated listed debt and money market instruments are capped to 5 per cent of net assets of the schemes.

Investment in debt instruments having structured obligations or credit enhancements
Investment in unsupported rating of debt instruments (without factoring in credit enhancements), which is below investment grade and supported rating of debt instruments (after factoring in credit enhancements), which is above investment grade, must not exceed 10 per cent of the debt portfolio of the schemes. Even the group exposure to such instruments is capped to 5 per cent. These limits are not applicable to investments in securitised debt instruments. Even the debt instruments having credit enhancements that are backed by equity shares directly or indirectly, must have minimum cover of 4 times the market value of such shares. Further SEBI says that the fund houses need to ensure that those debt investments having credit enhancements are realistically covered so as to address the market volatility and reduce the inefficiencies of invoking the pledge or cover, whenever required, without impacting the interest of investors. Keeping in mind the interest of investors, fund houses should initiate necessary actions in case the value of the cover falls below the specified limit. Further, investment in debt instruments with structured obligations or credit enhancements needs to be disclosed in the monthly portfolio statement of mutual fund schemes.

Sector level exposures
Previously, the sector level was capped at 25 per cent and now it would be capped at 20 per cent. Even the exposure limit for HFCs (Housing Finance Companies) has been reduced from 15 per cent to 10 per cent. Though, an additional exposure of 5 per cent of the net assets has been allowed for investments in securitised debt instruments based on retail housing loan portfolio and/or affordable housing loan portfolio. However, the overall exposure in HFCs should not exceed the sector exposure limit of 20 per cent of the net assets of the scheme.

Group level exposures
The investments made in debt and money market instruments of group companies of both the sponsor and the AMC (Asset Management Company) is capped at 10 per cent of the net assets. This limit can be extended up to 15 per cent of the net assets of the schemes with prior approval of the Board of Trustees.