Sebi cracks the whip on mutual funds

Sebi cracks the whip on mutual funds

What of market structure flaw creating risk?

Capital markets regulator Sebi’s attempt to improve prudential regulation that includes tighter investment rules for debt mutual funds and stricter disclosure for promoters’ share pledges is welcome. The idea is to make these schemes more secure, particularly after the IL&FS default that exposed the vulnerability of non-banking financial companies (NBFCs). The new rules mandate liquid funds to hold at least 20% of their money in liquid assets such as G-secs, cash, T-bills and so on. This will help improve risk management and aid liquid funds to handle large redemptions and, therefore, makes sense. Sebi has also reduced debt schemes’ investment exposure to each sector to 20% of the assets under management from 25%, and split the additional exposure limit of 15% to housing finance companies (HFCs) into 10% to HFCs proper and 5% to securitised home mortgages.

However, the problem with the real estate sector is its lack of access to long-term finance. Short-term credit from NBFCs, frequently rolled over, stands in for missing long-term capital, and a break in the cycle results in a crisis for both the financing companies and the builders reliant on them for capital. Fixing this market structure problem would reduce the risk to mutual fund investors more than prudential norms can. Liquid funds will not be allowed to invest in debt securities with credit enhancements. The regulator has also mandated security cover of at least four times for investment by mutual fund schemes in debt securities having credit enhancements backed by equities directly or indirectly. These wideranging changes will make debt funds more diversified and prevent them from investing in riskier securities. Henceforth, the valuation of debt and money market instruments to be based on mark to market. This is expected to benefit investors in the long term. However, a graded exit load on investors who exit liquid funds within seven days is debatable.

Making promoters of companies disclose detailed reasons for pledging or encumbrances if the total exceeds 20% of the company’s share capital or 50% of the equity holding makes sense.