Sebi modifies valuation norms for debt securities

Capital market regulator Securities and Exchange Board of India (Sebi) has modified the valuation methodology of debt securities, conceding additional discretionary room to mutual funds (MFs) with immediate effect.

Earlier, MFs could value rated debt instruments with duration up to two years at 100 basis points (bps) over and above, or 50 bps below the valuation provided by the Crisil matrix. Rating agency Crisil values bonds held by MFs at the end of the day as per a valuation matrix.
 

NOW AND THEN In case of unrated debt securities
Category	Current	Proposed
Instruments with duration upto 2 years	Discretionary discount of upto +50 bps over and above mandatory discount of +50 bps	Discretionary discount of upto +450bps over and above mandatory discount of +50 bps
Instruments with duration over 2 years	Discretionary discount of upto +50 bps over and above mandatory discount of +25 bps	Discretionary discount of upto +375 bps over and above mandatory discount of +25 bps

With this change, funds can value debt instruments they hold at 500 bps above the valuation, or 150 bps below the valuation. In the case of rated instruments over two-year duration, this has been increased to plus 400 bps above, or minus 100 bps below the Crisil valuation. Sebi has also similarly modified the discretionary room for unrated debt instruments.

This means that if yields of the underlying bonds where MFs have invested rise, their market value will drop, resulting in a lower net asset value (NAV) of the scheme, which is the case on Monday. The tight liquidity situation has resulted in yields shooting up and NAVs dropping. Investors in liquid, liquid plus and FMPs are seeing their investments lose value. Further, this also means that investors who are the first to redeem their investments get a higher NAV, while others get a lower NAV as the fund house has to sell off illiquid papers in the market.

The changes have come at a time when several fund houses have seen redemptions in their liquid and liquid plus schemes triggered by worries over the quality of the paper in which fund houses have invested.

“Because of tight liquidity, spreads have widened. So, actual trades were happening outside this valuation. The change in discretionary spread, now allowed by Sebi, will make MFs show an NAV that is correct and based on the market valuation,” said Roopa Kudwa, managing director and CEO, Crisil.

In many cases, even though the security enjoys an AAA rating from Crisil, it may trade at different prices because of the nature of the issuer — manufacturing company, non-banking finance company etc.

The Sebi circular to this effect mentions that the Association of Mutual Funds of India (Amfi) as well as Crisil brought to the notice of the regulator that the current valuation methodology is inadequate as debt securities of similar maturity and credit rating are being traded over a wide range of yields.