The Securities and Exchange Board of India (Sebi) today said that it is tightening the valuation norms for liquid funds. At the board meeting today the regulator decided to amend the Sebi Mutual fund regulations to bring down the threshold for marked to market requirements on debt and money market securities to 60 days from 91 days earlier. “In case debt and money market securities are not traded on a particular valuation day then valuation through amortization basis shall be restricted to securities having residual maturity of upto 60 days (currently 91 days), provided such valuation shall be reflective of the realizable value/ fair value of the securities,” Sebi said in a release after the board meet.
Liquid funds, as the name suggests, allow quick entry and exit to the investors and typically invest in money market instruments such as certificate of deposits, commercial paper and treasury bills.
The regulator also amended the rules and made it mandatory for fund houses to ensure fair treatment to all investors. AMC should ensure fair treatment “ to existing investors as well as to investors seeking to purchase or redeem units of Mutual Funds at all point of time in all schemes.”
The MTM valuation for money market and liquid instruments was introduced in July 2010 to avoid a repeat of the liquidity crisis in 2008, following the collapse of Lehman Brothers. However, this was limited to instruments with residual maturity of 91 days or more. As a result of this rule, implemented in July 2010, many fund houses booked heavy losses in FY11. For instruments of shorter tenure, fund houses follow the amortization method, where the returns on the instrument are prorated over the tenure of the instrument.
Earlier this week Arjun Parthasarathy, a fixed income expert and founder of investorsareidiots.com had told Business Standard the move to extend the MTM to instruments of shorter tenure will be welcome, “MTM reduces systemic risk. Without it, Funds are giving an implicit guarantee to the investors of a certain rate of return. But, unlike banks, they do not have the capital backing”
Corporates and banks have been using liquid funds as a cash management tool, since they are guaranteed of 3-4 per cent returns. Due to the amortization method used now, they do not experience volatility in the portfolio up to 90 days. But, this is an illusion created by the amortization method, which could get exposed in extreme events like the Lehman collapse, experts said.
According to Parthasarathy the new rule, if implemented, will bring volatility in the liquid fund NAVs. “Returns on liquid funds will take a hit and the corporate money will look for other options bringing down the assets under management,” he added.
RBI and Sebi have repeatedly expressed concerns about banks and corporates round tripping investments using liquid funds. Fund houses have lost significant money in liquid funds since in May, RBI capped banks’ investments in liquid funds at 10 per cent of their networth .
According to AMFI, Assets under management of liquid and money market schemes nearly halved to Rs 1.2 lakh crore or 20 per cent of the industry, in December 2011. At the end of April 2011, liquid funds managed Rs 2.2 lakh crore, accounting for 28 per cent of the industry.
