How SEBI is Planning to Ensure Franklin like Episode Does Not Get Repeated

Oct 14, 2020

Ever since Franklin Templeton wound up six of its debt schemes and left its investors in a lurch, SEBI intensified its efforts to fix debt funds.

The market for debt securities beyond highest quality paper remains illiquid due to heightened risk aversion amid the COVID-19 crisis. In the event of unanticipated redemption pressure, debt funds with higher allocation to papers rated below AAA may find it difficult to manage the portfolio.

Thus, SEBI wants mutual funds to take all the necessary measures to prevent a repeat of Franklin like episode. Since May, SEBI has announced numerous steps to fix regulatory and operational loopholes in order to protect investors' interest and promote growth of debt funds.

Firstly, it allowed mutual fund houses to list the units of mutual fund schemes that are in the process of winding up on recognized stock exchanges in order to provide an exit option to investors. Next, SEBI tweaked the limit on certain categories of mutual funds on a temporary basis to permit them to invest an additional 15% in government securities and treasury bills to make the portfolio more liquid.

Further, to ensure better transparency and disclosure pertaining to debt schemes, SEBI has introduced two new norms based on the recommendation of Mutual Fund Advisory Committee (MFAC). These norms came into force from October 1.

Mutual funds are now mandated to undertake at least 10% of their total secondary market trades by value (excluding inter-scheme transfer trades) in corporate bonds/commercial papers through one-to-many mode on the Request for Quote (RFQ) platform of stock exchanges. Trading through RFQ platforms is expected to bring in better price discovery and transparency for corporate bonds as well as increase liquidity on the exchange platforms.

In another move, SEBI has asked all debt schemes to disclose portfolio on fortnightly basis (as compared to the current practice of disclosure on monthly basis) within five days of every fortnight. Additionally, the portfolio disclosure should mention yields of the underlying instruments, which would give investors a better sense of the risk factor.

Another change that came into force from this month is that mutual funds are now required to disclose the details of debt and money market securities transacted (including inter-scheme transfers) in its schemes in a new prescribed format. The new format for disclosure of securities transacted is more comprehensive and includes details such as the name and type of security, credit rating, name of the rating agency, maturity date, settlement date, interest accrued, and yield, among others.

[Read: SEBI Brings In New Norms to Improve Transparency in Debt Mutual Funds]

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​More norms will come into force from January 01, 2021. This includes additional restriction on inter scheme transfers (IST) in open-ended and close-ended schemes.

Close-ended schemes will be allowed IST purchase only within three business days of allotment pursuant to New Fund Offer (NFO). Open-ended schemes will be permitted IST to manage unanticipated redemption pressure after the scheme has exhausted the option of using cash & equivalent, market borrowing and selling of securities in the market; and to rebalance the portfolio to meet the regulatory limit relating to duration, issuer, sector and group, provided that balancing is required in both the transferor and transferee schemes.

The move is expected to promote enhanced accountability on the part of the fund house and the fund management team of both the transferor and transferee scheme.

[Read: Can SEBI's New Inter Scheme Transfer Norms for Mutual Funds Lead to Better Accountability?]

SEBI has also improvised the risk-o-meter to enable investors to make better choices when picking schemes for investment. The risk-o-meter will now reflect the actual risk of a particular scheme based on its portfolio and not just the broader category to which it belongs. This will come into force from January 01, 2021.

Meanwhile, SEBI is mulling more measures which are expected to be implemented over time in consultation with the mutual fund industry. Here are some of the measures under consideration:

  1. Mandatory 10% minimum exposure in liquid assets such as government securities, cash, treasury bills, and tri-party repo

  2. Gating of redemptions during extreme events to prevent any pressure on the fund

  3. Assess whether the side-pocket creation norms need to be revisited

  4. Stress testing for all open-ended debt oriented mutual fund schemes that will raise early warning signs and enable AMCs to take necessary actions

  5. Swing Pricing / Anti-dilution levy to pass on the cost of transaction to the transacting investor undertaking large redemption in time of crisis

  6. Facilitate repo in corporate bonds in order to increase liquidity in secondary markets and to enable greater issuances of paper rated below AAA

  7. Setting up of back-stop facility i.e. an entity that would buyout illiquid corporate bonds from debt funds in times of stress

[Read: How SEBI Plans To Ensure That Liquidity of Debt Funds Is Not Compromised]

[Read: SEBI Chairman Proposes Additional Measures to Make Debt Mutual Funds Safer]

SEBI has taken bold and important steps to make debt funds safer. But as an investor, you too need to exercise precaution while picking schemes for investment. Invest in schemes that align with your risk appetite, investment objective and the time horizon to goal and assess the following factors to pick worthy schemes:

  • The portfolio characteristics of the debt schemes

  • The average maturity profile

  • The corpus & expense ratio of the scheme

  • The rolling returns

  • The risk ratios

  • The interest rate cycle

  • The investment processes & systems at the fund house

At PersonalFN, we arrive at top rated funds using our SMART Score Model. If you wish to select worthy mutual fund schemes, I recommend that you subscribe to PersonalFN's unbiased premium research service, FundSelect.

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Warm Regards,
Divya Grover
Research Analyst

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