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Lack of uniformity in valuation arbitrage prompts Sebi to tweak norms
Different levels of haircuts and different days of taking haircuts for distressed assets was also seen as giving advantage to a certain set of investors
The Securities and Exchange Board of India (Sebi) has pointed out that lack of uniformity in valuation methodology might have aggravated the recent redemption pressures faced by liquid schemes as first-to-exit investors got an unfair advantage of higher net asset values (NAVs) over the invested unitholders.
The regulator, in its board meeting, note pointed out that liquid schemes had seen one-fourth of the assets getting wiped out, following the Infrastructure Leasing & Financial Services (IL&FS) crisis, even though the total exposure of mutual fund (MF) schemes to the IL&FS group was limited to Rs 5,200 crore as on August 31, 2018. The note was put out by Sebi on Tuesday. The regulator observed that there was an incentive for investors to rush in with their redemption requests during volatile conditions, as underlying assets were not priced in line with the fair value of the assets.
“...valuations, which are not reflective of the realisable price of an asset, may encourage first-mover advantage associated with redeeming at the onset of market volatility, at the cost of the remaining investors and may also exacerbate redemption pressure on the fund,” Sebi said.
“Earlier, MFs could value securities with maturity of up to 60 days on an accrual basis. The prices were not closer to the realisable price, which led to some arbitrage. A market-linked mechanism means that all investors would be able to get exits at fair value,” said Kaustubh Belapurkar, director (fund research), Morningstar India.
To make sure the liquid schemes more closely reflected the underlying portfolio risks, Sebi, in its March 1 board meeting, had stated that all debt papers with maturity of 30 days or more should be marked-to-market. Earlier, fund houses didn’t have to mark-to-market securities that had less than 60-day maturity.
Different levels of haircuts and different days of taking haircuts for distressed assets was also seen as giving advantage to a certain set of investors. “All asset management companies (fund houses) have not applied the haircut immediately on the day of the credit event... such practice may also have resulted in first-mover advantage, with certain investors taking advantage of the gap between the credit event and the date of taking the haircut, by redeeming at a higher NAV,” the regulator said in its note.
To remove these variances, the regulator recently stated that all debt securities rated below investment grade shall be valued at price provided by valuations agencies.
Till the time these valuations are computed, fund houses will have to immediately markdown the assets on the day of downgrade as per indicative haircuts given by agencies.
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