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Sebi to tweak liquidity norms for debt funds

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Mumbai: The markets regulator, Securities and Exchange Board of India (Sebi) has set up a working group to assess the liquidity risk management of debt funds. The working group is tasked to tweak the liquidity forms for debt funds, especially open ended, said two people with direct knowledge of the matter.

“A 10% exposure to liquid assets, stress testing, gating of redemptions to prevent a run on the fund, a relook at side-pockets whether norms need to be revisited are some of the broad terms of reference. This to ensure that liquidity and risk management norms are adequate for open ended debt funds,” said the first of the two people quoted above.

This relook comes after Franklin Templeton India debt fund crisis, where the fund house shut down its 6 debt schemes owing to severe illiquidity and redemption pressures. The shuttering of these 6 debt schemes had a domino effect on the other fund houses specifically on funds that took credit risks.

Credit risk funds which invests more than 65% of their assets in lower rated instruments lost saw consistent outflows in April, May and June of 19,239 crore, 5,173 crore and 1,494 crore respectively. The recent credit crisis has continued to adversely impacted fixed-income markets leading to investors treading a line of caution by staying away from riskier investments.

“Anticipating that debt funds are not completely out of woods Sebi’s thought process is to ensure that open ended schemes have enough liquidity buffer to withstand redemption pressures. A 10% mandatory liquidity cushion by investing in g-secs could help in making open ended-debt funds more liquid. Also a mandatory stress test of debt funds would also be helpful,” said the second of the two people quoted above.

In the month of May Sebi had allowed certain category of debt funds to invest an additional 15% in liquid assets to meet the temporary covid-19 related redemption stress.

Another key consideration for the working group is to consider whether redemptions can be gated or stopped at a certain threshold.

“The working would need to define whether it is feasible and at what % of assets under management (AUM) should the redemptions be stopped,” said the second person.

“These terms of reference are good but do not address the underlying illiquidity of the debt market in India. Liquidity buffer is a great initiaitve, specifically for debt categories at the short end. Gating redemptions is good in theory but should be clearly communicated to investors in SIDs (scheme information document) at the time of investment, given that it goes against the promise of a fund’s open-ended nature. Also, it will be interesting to see how problems such as concentration of papers in schemes for those remaining in the scheme after a mass exit can be addressed,” said Vidya Bala, co founder, Primeinvestor, an investment advisory firm.

In addition, Sebi has also tasked the working group to look at the side-pockets. Sidepockets were introducted by Sebi in December 2018 as a way to ensure money invested in a mutual fund debt scheme that is linked to stressed assets gets locked until the fund recovers the cash from the company. Investors can redeem the rest of their money. Since then the asset managers have created about 35 sidepockets for their bond exposures to Yes Bank Ltd, Vodafone-Idea Ltd, Adilink Infra and Multitrading Pvt ltd, Altico Capital India Ltd, Dewan Housing Finance Ltd (DHFL), Zee Learn.

“Whether some more checks are needed for creation of side-pockets, have these added to risk in debt funds are some aspects the working group would consider,” said the first person quoted earlier in the story.

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