The Securities and Exchange Board of India (Sebi) wants mutual funds
(MFs) to build mechanisms that can give early-warning signals to indicate a deteriorating credit profile of a borrower. According to sources, the market regulator wants sudden yield movements to be included in this system to improve MFs’ ability to track build-up of stress.
“Sudden spikes in yields can give an early signal of stress build-up or liquidity issues. However, the industry would need to evolve a nuanced approach and fine-tune it further,” said Dwijendra Srivastava, chief investment officer (fixed income) at Sundaram MF.
The sources said the regulator wants MFs to rely less on rating agencies as the latter have been slow to react or flag credit risks in recent cases.
“Rating agencies are more closely-linked to issuers and less in-tune with the daily market movements. This is also one of the reasons why rating agencies have reacted with a lag even though fundamentals of certain entities were on a slippery slope,” said a fund manager.
Rating agencies are facing heat for their role in the IL&FS crisis. Grant Thorton's draft report alleged that some rating agencies were working with the group’s management and ended up covering the underlying stress.
also wants MFs to rein in their exposure to complex debt investments that are backed by promoter pledging or any other guarantee given by parent entity or promoters. According to industry officials, Sebi
has decided to put in place the curbs after a working group of industry participants, along with the regulator’s advisory committee, saw instances where standalone ratings of the entity would not be investment grade if not for the backing of promoters or other entities.
In June, the market regulator pegged the limit on a scheme's exposure to credit-enhanced investments to 10 per cent, if the credit-enhancement is being used to prop up the ratings to investment grade. Liquid and overnight schemes have been disallowed from making any investment in such securities.
Promoter-backed debt instruments came into the spotlight earlier in the year after the promoters of Essel Group entered into a ‘standstill’ agreement with MFs and other lenders. The agreement meant that MFs or other lenders will not sell the pledged shares of promoters and also give extra time to promoters to repay dues by September. Liquidity crunch faced by non-banking financial companies has worsened investor nervousness. “The pace of downgrades and defaults has only worsened since the IL&FS crisis. Investors have had to bear the brunt of it as rating actions have translated into a sharp hit on returns. Developing a more robust risk-management framework and limiting such events would be key to restoring investor confidence,” said senior executive of a fund house.
The slew of rating downgrades and instances of defaults have led a large flight of investor money from debt MFs. Since the IL&FS crisis spooked the markets
in September last year, investors have pulled out Rs 68,000 crore from fixed-income schemes (up until March 31, 2019). Since April (since granular data is disclosed), credit risk funds have seen Rs 8,100 crore of outflows.
• Wants MFs to track emerging credit risks in exposures
• Rating agencies have been slow to flag-off troubles
• Daily yields, other changes can be used by MFs as signals
• Wants MFs to avoid structured debt as parent backing may prop up rating