In a circular issued today, markets regulator Sebi has heavily restricted the use of inter-scheme transfers (ISTs) by debt mutual funds. Inter scheme transfers involve shifting of debt papers from one mutual fund scheme to another. Under existing rules, Sebi only requires that such ISTs be done at market prices and that the transfer should be in conformity with the investment objective of the recipient scheme.
However, several mutual fund houses resorted to such ISTs when redemption pressures piled up in April and May 2020 on their credit risk funds, thereby shifting risk to other types of funds which are not labelled as credit risk. According to Sebi data, ISTs of ₹60,306 crore have been done since FY 2020-21 alone (till end of August 2020). The highest number of such ISTs were done in April 2020 worth ₹21,815 crore.
Under the new Sebi circular, which takes effect from 1 Jan 2021, ISTs in close ended funds can only be done within 3 business days of the allotment of the scheme’s units to investors and not thereafter. In case of open ended funds inter scheme transfers will be allowed to meet unanticipated redemptions or to rectify breaches of regulatory limits, but only under certain conditions.
When the fund is doing ISTs to meet redemption pressure, the fund manager must first use the cash and cash equivalents in the scheme to meet them. Thereafter he has the option to use market borrowings or sell securities. It is only if the above avenues are not sufficient that the fund manager can resort to ISTs.
“This is a continuation of Sebi’s ongoing exercise of streamlining and structural reforms of debt funds, as we also saw in the recent circular on riskometer being adjusted to a scheme’s portfolio. It will further improve risk management in debt funds,” said Mahendra Jajoo, Chief Investment Officer – Fixed Income, Mirae Asset Investment Managers (India) Pvt Ltd.
A debt fund can also do ISTs to avoid breaches of Sebi’s limits on exposure to a single issuer, group, sector or a duration limit laid down by the regulator.
However in such cases different reasons cannot be cited by the transferor and transferee scheme. In addition, trustees of the fund have been required to put in place a mechanism to affect the performance incentives of fund managers and CIOs in case the security becomes default grade within 1 year of transfer.
In addition, the circular laid down that if a security gets downgraded within 4 months of doing an IST, the fund manager of the buying scheme is required to furnish a detailed explanation of why the IST was done. “Inter scheme transfers have been misused by AMCs. Sebi knew and would have seen certain abuses of inter scheme transfers in April-May this year and this is what the regulator is trying to curb. The second point is that AMCs would have to manage liquidity at the scheme level rather than fund house level because now ISTs are more difficult. In other words, they would have to hold more cash,” said Arvind Chari, Head of Fixed Income and Alternatives, Quantum Advisors Pvt Ltd.
Sebi also laid down that no ISTs shall be allowed if there is any negative market news or rumour about a security in the mainstream media or an alert is generated about a security by the fund’s internal risk assessment in the previous 4 months. This provision has drawn some criticism from industry experts. “This provision is highly subjective and will cause a wave of risk aversion in the industry,” said a debt fund manager at a midsized fund houses on condition of anonymity.