SEBI Circular: Liquid And Overnight Fund Portfolios To Become More Transparent; But Exit Loads Will Apply For Early Redemption

SEBI has tweaked some fund management regulations for the liquid and overnight funds categories, through a Circular issued on September 20.

Here, we discuss these changes and focus on how these impact you. To start with, liquid funds are defined as money-market funds investing in instruments maturing within 91 days. For daily NAV computation, the valuation of the instruments with a maturity period of over 30 days is provided by rating agencies CRISIL and ICRA. For instruments maturing within a maximum of 30 days, valuation for daily NAV purposes happens on an amortization basis; that is, returns come from the accrual only, without the mark-to-market impact.

New rules apply

The Circular states that from April 1, 2020, liquid funds shall invest a minimum of 20 per cent in ‘liquid assets,’ defined as Cash, Government Securities, T-bills and Repo on Government Securities. It is a prudent step to have 20 per cent in liquid assets of good credit quality, which would be useful in meeting redemption pressures. The concept is similar to that of SLR for Banks, which is a mandatory holding of good-quality liquid assets. The liquid fund industry has managed redemption pressures, even when system liquidity has been tight and redemptions have been heavy, at more than 20 per cent of their corpus. As and when this measure becomes effective, it will improve the portfolio quality and liquidity of any fund that has not been consistent in maintaining portfolio quality.

To further simplify the portfolio composition of liquid and overnight funds, it has been stated that these funds shall not invest in debt securities having structured obligations (SO rating) and/ or credit enhancements (CE rating). Though rating agencies would take into account the strength of the structure or enhancement for assigning the rating, excluding these from liquid / overnight funds would make the portfolio that much simpler and cleaner. This rule applies with immediate effect for fresh investments.

One unique feature of these two categories of funds is the applicability of the previous day NAV. So, even though you give funds to the AMC today, within the cut-off time, your starting NAV is that of the previous day. Effectively, you get one more day of return than you do from other categories of funds. There has been a tweak in this norm: cleared funds should reach the AMC by 1:30 pm instead of 2 pm, effective October 20, 2019. This would give more leeway to the AMC to deploy funds in TREPS (Tri-party repo), as otherwise it was generally a rush when funds reached only towards the last hour.

There would be an exit load applicable on redemptions from liquid funds if sold within seven days of investment. This would be applicable from October  20, 2019. This implies that investors in liquid funds, particularly corporate investors, will have to plan cash flows accordingly. However, given that Liquid Funds are cash management products, imposition of exit load goes against the grain. Overnight Funds will not have any exit load and can be utilized for parking of funds for short horizons of less than seven days. Overnight Funds are safer than even liquid funds, but returns would be relatively lower.

Apart from the provisions discussed above, in the SEBI Board Meeting held on June 27, 2019, it was discussed that “The valuation of debt and money market instruments based on amortization shall be dispensed with completely and shall be based on mark-to-market.” As and when this is implemented, there would be a mild volatility in returns from liquid funds, but it will reflect the true market picture. In case of redemption pressure and the AMC selling instruments in an illiquid market, the realisable value will be closer to the NAV.

Thus, liquid funds will be more robust in terms of portfolio transparency, but would come with a minimum-7-days holding period tag to avoid exit loads. As and when the NAV moves towards complete mark-to-market valuation from the current norm of more-than-30-day maturity, there would be mild volatility. However, returns from liquid funds move more with RBI signals on interest rates, i.e., repo rate (currently at 5.4 per cent) and system liquidity surplus/deficiency. In such cases, mark-to-market valuation would not make as much of a difference.


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