Sebi looks to tighten rules for liquid funds

Securities and Exchange Board of India may soon tighten norms for liquid funds, the most popular mutual fund product among institutional investors with average assets under management of over Rs 6 lakh crore. Some of the proposals that the capital market regulator is considering for liquid schemes are mandatory minimum investments in short-term government bonds and stricter valuation norms, said three people familiar with the matter.

A plan to introduce a lock-in for investments in liquid funds is also being discussed but Sebi is treading with caution on the issue as it could dent the product and affect activity in the money markets.

These proposals, aimed at reducing risks in liquid funds, are likely to be taken up in the Sebi’s board meeting scheduled in mid-February.


As the Mutual Fund Advisory Committee (MFAC), appointed by the regulator to decide on reforms for mutual funds, is yet to formally meet to discuss these measures, it is not clear how the final rules would take shape. An email query to Sebi seeking responses on these matters went unanswered till the time of going to print.

The regulator’s decision to tighten rules for mutual funds comes in the wake of the crisis at the IL&FS Group, which defaulted on its payments to various investors including mutual funds. The net asset value (NAVs) of liquid funds, which owned IL&FS papers, had taken a knock to the extent of 50 per cent of the product’s annual average returns of 6-7 per cent.

There are stark differences among members of Sebi-appointed MFAC over the recommendations. The plan to ask liquid funds to keep a minimum amount in treasury bills — government bonds with a maturity of less than one year — is aimed at ensuring better liquidity.

The regulator is yet to decide the extent of such investments, but industry officials said these schemes could be required to invest at least15-20 per cent of their assets under management in treasury bills with 90 days maturity. “It will be prudent because with treasury bills, mutual funds can always tap the CBLO market to borrow,” said a person privy to the matter. In CBLO or Collateralised Borrowing and Lending Obligation — a market for overnight borrowing and lending for mutual funds, insurers and NBFCs — treasury bills are used as collateraltoborrow.

The other point of contention has been the over the plan to introduce a minimum investment period for liquid funds. There was a suggestion to bring in a seven-day lockin for liquid funds to ease the volatility in flows, but this proposal has met with maximum opposition from the MFAC and the industry. Three people, who are aware of the proposals, said Sebi is unlikely to implement a lockin for liquid scheme investments. Mutual fund officials said the step would have an adverse impact on the popularity of the product among corporates — the biggest investors in liquid funds. “A lock-in would kill the product. So, this proposal looks highly unlikely at this stage,” said one of the persons quoted above.

Companies park their idle funds in liquid funds, which allow them to redeem at will. But the criticism has been that the instant redemptions impact the stability of the fund.

Sebi may also ask liquid funds to ‘mark-to market’ bonds with maturity above 30 days, the people said. Liquid funds invest in debt papers with maturities of less than 90 days, but they do not have to mark to market securities that mature under 60 days. If the regulator cuts this requirement to 30 days, funds would prefer to invest in only one-month commercial papers as marketlinked valuations would increase volatility.

Fund managers said borrowers would reduce dependence on liquid funds due to pressure on retiring debt in 30 days.

“Borrowers can effectively keep the money for 21-22 working days. It is going to be stressful for companies,” said a senior mutual fund industry official. “The indirect impact of this would be that it would dry up volumes in the overnight market.”

The regulator may also reduce the flexibility that now gives funds to mark up the valuations of securities in liquid schemes.