In order to bring uniformity and consistency in valuation, market regulator Sebi has asked mutual fund houses to follow "waterfall" approach for the valuation of money market and debt securities.
Under this approach, all traded securities would be valued on the basis of traded yields, subject to identification of outlier trades by the valuation agencies.
Besides, the regulator has come out with a framework relating to valuation of inter-scheme transfers and barred the use of own trades for valuation.
Further, the regulator said a money market or debt security will be classified as "below investment grade" if the long-term rating of the security issued by a credit rating agency (CRA) is below BBB- or if the short-term rating of the security is below A3.
A money market or debt security will be classified as "default" if the interest and/or principal amount has not been received on the day such amount was due or when such security was downgraded to "default" grade by a CRA.
In the case of default, mutual funds will have to promptly inform to the valuation agencies and the CRAs any instance of non-receipt of payment of interest and/ or principal amount (part or full) in any security.
In a circular issued on Tuesday, Securities and Exchange Board of India (Sebi) said, "for arriving at security-level pricing, a waterfall approach shall be followed for the valuation of money market and debt securities."
A money market fund, in market parlance, is an open-ended mutual fund which invests in short-term debt securities like treasury bills and commercial paper. Debt securities funds invest in fixed income securities like bonds and treasury bills.
Spelling out broad principles that need to be adopted under the waterfall approach, for arriving at the security level prices, the regulator said that "all traded securities shall be valued on the basis of traded yields, subject to identification of outlier trades by the valuation agencies".
Volume weighted average yield (VWAY) for trades in the last one hour of trading will be used as the basis for valuation of government securities including treasury bills, Sebi said.
"Valuation of all other money market and debt securities (including government securities not traded in the last one hour) shall be done on the basis of VWAY of all trades during the day," Sebi said.
The market watchdog asked the Association of Mutual Funds in India (Amfi) to ensure that valuation agencies have a documented waterfall approach for valuation of money market and debt securities.
Considering the importance of polling in the valuation process, Sebi asked Amfi to issue framework on polling by valuation agencies and on the responsibilities of mutual funds in the polling process, as part of the approach.
Valuation agencies will identify the mutual funds who will participate in the polling process on a particular day, taking into account factors such as diversification of poll submitters and portfolio holding of the mutual funds.
Mutual funds, who are identified by the valuation agencies, will have to necessarily participate in the polling process. However, in case any fund does not participate in the polling process, detailed reason for the same will have to be recorded and made available during Sebi inspections.
In case an asset management company (AMC) decides to deviate from the valuation price given by the valuation agencies, Sebi said that the detailed rationale for each instance of deviation will be recorded by such AMC.
With regard to use of own trade for valuation, Sebi noted that various instances have come to notice wherein mutual funds have used their own trades of relatively small quantity in order to value the entire holding of such security.
In order to address possible misuse, the regulator said that mutual funds will use their own trades for valuation of debt and money market securities and for inter-scheme transfers (IST).
With respect to IST, Sebi said that AMCs will have to seek prices for IST of any money market or debt security (irrespective of maturity), from the valuation agencies. Then, Amfi, in consultation with valuation agencies will decide a turn-around-time (TAT), within which IST prices will be provided by the agencies.
If prices from the valuation agencies are received within the pre-agreed TAT, an average of the prices so received will be used for IST pricing. In price from only one valuation agency is received within the agreed TAT, that price may be used for IST pricing.
In order to enable consideration of all trades during a day for valuation, Sebi has extended the present timeline up to 11 pm for uploading the net asset values of all schemes (except Fund of Fund schemes) on the website of Amfi and AMCs.
While making any change to terms of an investment, which may have an impact on valuation, Sebi said that mutual funds will report the same to the valuation agencies immediately.
"Any extension in the maturity of a money market or debt security shall result in the security being treated as "default", for the purpose of valuation," it added.
In case, the maturity date of such security is shortened and then subsequently extended, the security will be treated as "default" for the purpose of valuation.
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