Investor protection was a key discussion point for the Securities and Exchange Board of India (Sebi) at its board meeting on Thursday. This is evident from the slew of changes that the regulator announced in mutual fund regulations in the wake of the liquidity crisis, which has affected several schemes. In the case of Infrastructure Leasing & Financial Services and Dewan Housing Finance Corporation, the downgrades in the ratings of their debt resulted in fund houses not finding an exit without a sizeable loss. Several fund houses entered into standstill agreements with promoters of Essel group and Anil Ambani group. Under the agreement, mutual funds, which had bought debt securities of privately-held firms with listed shares as collateral, would not sell the shares till a particular date. Due to the standstill in the case of Essel group papers, a few close-ended schemes were not able to pay the entire proceeds to unitholders at maturity.
Under the new rules, liquid schemes will now have to maintain at least 20 per cent in liquid assets including cash, government securities (g-secs), treasury bills, and repo on g-secs. Their sectoral investment cap has been cut from 25 per cent to 20 per cent, and the additional exposure to housing finance companies stands reduced from 15 per cent to 10 per cent. Valuation of papers can no longer be done on amortisation but on a mark-to-market basis. It has also restricted investments of a scheme in debt and money market instruments having credit enhancements of a particular group to 10 per cent and 5 per cent, respectively. In mutual funds’ investments in debt securities having credit enhancements backed by equities, Sebi
has raised the security cover to at least four times. It has also disallowed the use of a fund house’s own trades for valuation in case of inter-scheme transfer.
On the equity side, the new rules say all fresh investments in shares by mutual fund schemes will be made only in listed or to- be-listed shares. Sebi
has also tightened the screws on loan against shares, which has come to haunt lenders, including the mutual fund industry in some recent cases. It has expanded the definition of encumbrance and instructed promoters to disclose separately detailed reasons for encumbrance, when it crosses 20 per cent of the company’s total share capital or 50 per cent of the promoters’ holdings, which must be disclosed on the stock exchanges.
It’s clear that both corporate and retail investors will see their returns from debt funds come down and promoters are likely to find it tough to raise money as refinancing will become tougher. But it’s better to be safe than sorry when retail investors are involved. With some key loopholes plugged, Sebi’s new proposals ensure that mutual funds do not step out of line and go a reasonable distance in protecting the investor. After all, mutual funds are not banks and their job is to invest on behalf of their unitholders. The Sebi
chief is right in saying that the regulator does not recognise standstill agreements between fund houses and defaulting promoters, a practice that needed to be stopped.