Sebi proposes net fund settlement for mutual fund cash-market trades

Sebi has proposed allowing mutual fund schemes to settle funds on a net basis for some cash-market transactions, a move aimed at reducing temporary liquidity pressure on schemes while keeping securities settlement on a gross delivery basis.

The market regulator issued a consultation paper on September 3 seeking public comments on the proposal. Comments can be submitted till September 24.

The proposal applies to outright buy or sell transactions undertaken by mutual fund schemes in the cash market on recognised stock exchanges. Sebi said the move is intended to improve settlement efficiency, ease operational pressure and reduce temporary funding needs without changing safeguards linked to delivery-based settlement, scheme-wise accounting, valuation and investor protection.


What Sebi has proposed

Under the proposal, mutual fund schemes will be allowed to net fund obligations only for outright transactions. An outright transaction means either a purchase or a sale in a security during a settlement cycle, but not both.

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For example, if a mutual fund scheme buys one stock and sells another stock in the same settlement cycle, the fund obligation for those eligible trades may be netted. But if the scheme buys and sells the same security in the same settlement cycle, that security will be excluded from netting and will continue to be settled on a gross basis.

Sebi has made it clear that only fund settlement will be netted. Settlement of securities will continue on a gross basis. Securities transaction tax and stamp duty will also continue to be levied on a delivery basis.

The regulator has also proposed that netting should be allowed only at the level of an individual mutual fund scheme. No netting will be permitted across different schemes of the same mutual fund or AMC.

Why the change is being considered

Under the current framework, institutional investors cannot do intra-day squaring off in the cash market. Their trades are grossed at the custodian level and obligations have to be fulfilled on a gross basis. This keeps the system delivery-backed, but it also means mutual fund schemes must arrange funds for purchases separately, even when sale proceeds are receivable in the same settlement cycle.

Sebi said this can create temporary gross funding requirements at the scheme level, even when the net cash obligation is limited. The issue can become more visible during index rebalancing by passive funds or when schemes face large subscriptions or redemptions.

The regulator noted that it had already allowed net settlement of funds for outright transactions by foreign portfolio investors in the cash market through an April 24 circular. A similar but tailored framework is now being proposed for mutual funds.

The Mutual Fund Advisory Committee had also recommended allowing net settlement for domestic institutional investors in line with the framework permitted for FPIs. Sebi said the proposal may also reduce the extent of intraday borrowing used by mutual fund schemes for settlement purposes.

Safeguards to remain

Sebi has sought to limit the proposal so that it does not permit trade netting or delivery netting. The delivery-backed framework, scheme-wise accounting, daily NAV computation, asset segregation and borrowing norms will continue to apply.

If outright sale value is lower than outright purchase value, the residual amount will have to be funded by the concerned mutual fund scheme. If outright sale value is higher than outright purchase value, the excess sale amount cannot be adjusted against non-outright purchase obligations.

Any external funding arrangement used for balance payment obligations will still have to comply with mutual fund borrowing rules.

The proposal is likely to be watched closely by AMCs, custodians and clearing corporations because it can ease short-term liquidity pressure without changing the basic delivery-based settlement structure.

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