Sebi plans net settlement for mutual fund trades in cash market

Mumbai: The Securities and Exchange Board of India (Sebi) Thursday proposed allowing net settlement of funds for transactions undertaken by mutual fund schemes in the cash market, a move aimed at easing temporary liquidity pressures and improving settlement efficiency.

Under the proposed framework, mutual funds would be allowed to net funds for outright purchase and sale transactions undertaken on recognised stock exchanges, while the underlying securities would continue to be settled on a gross, delivery basis.

An outright transaction would mean either a purchase or a sale of a security, but not both, by a mutual fund scheme during the same settlement cycle. Transactions where a scheme both buys and sells the same security during a settlement cycle would be excluded from netting and would continue to be settled on a gross basis.


The regulator said it received representations from market participants that mutual fund schemes may face temporary liquidity requirements and operational inefficiencies because fund obligations in the cash market are effectively met on a gross basis at scheme level.

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"These issues may become more pronounced during index rebalancing which requires portfolio changes in passive funds and large investor subscriptions or redemptions," Sebi said in a discussion paper.

"In such cases, where a scheme has outright purchase obligations in some securities and outright sale receivables in others within the same settlement cycle, gross funding can result in avoidable liquidity deployment, despite the scheme having offsetting cash flows within the same cycle."

Besides, Sebi has already allowed net settlement of funds framework for foreign portfolio investors.

Currently, mutual fund schemes undertaking transactions in the cash market are required to follow a delivery based settlement discipline.

Further, institutional transactions are grossed at custodian level and obligations are required to be fulfilled on a gross basis.

Also, under the current framework, a mutual fund scheme is required to arrange funds for purchase transactions independently of sale proceeds receivable in the same settlement cycle, even where the same scheme has offsetting outright purchase and outright sale transactions.

"As a result, even where the net cash obligation of the scheme is limited, the existing framework leads to temporary gross funding requirements at the scheme level, resulting in liquidity pressures, operational inefficiencies and reliance on short-term funding arrangements for settlement," Sebi said.

The regulator has proposed several safeguards. Netting would be permitted only at the individual scheme level, with no adjustment of obligations between different schemes of the same asset management company.

Sebi said delivery backed nature of institutional trades would remain unchanged. Securities would continue to be settled on a gross basis, while securities transaction tax and stamp duty would continue to be levied on a delivery basis, where applicable.

Where outright purchases exceed sales, the residual obligation would have to be funded by the scheme. Excess proceeds from outright sales could not be used to meet non outright purchase obligations, it said.