The Securities Exchange Board of India (SEBI) has been the more proactive among India’s financial regulators in responding to the challenges posed by the liquidity crisis in debt markets. After a series of changes designed to improve disclosure for rating agencies and enforce realistic bond valuation norms on mutual funds, SEBI’s recent board meeting focussed on curbing risk-taking in debt funds.
Most of the proposed measures seek to make liquid funds safer for investors. A new requirement is that liquid funds hold at least 20 per cent of their investments in cash and sovereign paper. This is much-needed because the main investment proposition of liquid funds is to offer anytime liquidity which may not be possible if they are mainly invested in corporate paper. Graded exit loads will be levied on liquid fund exits within seven days, preventing large investors from indiscriminately churning their holdings. Transitioning all bonds to a mark-to-market valuations will force liquid and overnight funds to transact at more realistic NAVs. Structured obligations will be barred for overnight and liquid schemes and the maximum exposure to a single sector pruned from 25 to 20 per cent, curbing their dalliance with promoter loans and NBFCs. The net effect of all these measures would be to temper the returns of liquid funds. This could prompt corporate treasuries, their predominant investors, to seek greener pastures in bank deposits. However, other categories of debt funds seem to have gotten off lightly. Yes, risky promoter loans against shares may turn unviable with SEBI insisting on a security cover of four times and looking to bar investments in unlisted bonds. The regulator has also put a stop to the dodgy practice of fund houses using inter-scheme transfers to value unsaleable bonds. But no solutions have been found to other forms of risk-taking by debt funds, such as overshooting concentration norms post investment and accommodating group companies, which have significantly hurt retail investors in Fixed Maturity Plans.
Overall, while SEBI’s single-minded focus on investor protection is laudable, attempts to draw red lines around where the fund industry can invest do have adverse consequences for bond market development. Stricter curbs on NBFC and promoter loan exposures for instance, are bound to stifle a key source of funding for these market participants. While retail investors in debt funds do need protection from such risks, there’s no reason why corporate treasuries, institutions and high net worth investors in debt funds must not be allowed to take on high risks and fend for themselves. As of March 2019, 97 per cent of assets in liquid funds and 90 per cent in other debt funds were contributed by institutional and HNWIs. Requiring the fund industry to segregate its debt products into retail and institutional may allow the regulator to take a more nuanced view.