How the prudential norms for liquidity risk management impact the MF industry?

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Markets watchdog Securities and Exchange Board of India (Sebi) recently issued prudential norms for liquidity risk management for open-ended debt schemes. These norms found their first expression in the Sebi’s circular of November 6, 2020. The current circular is in connection with its actual implementation. 

Except for overnight funds and gilts funds, in all the other categories of debt funds, the liquidity maintained should be 10%, and it should be in the form of cash and cash equivalents, including treasury bills and government securities, etc.

How will this impact fund houses?

 Financial experts don’t see this will impact the AMC’s as almost all open-ended debt mutual funds currently have a 10% exposure to liquid assets.

 “Holding 10% liquid assets improves the liquidity profile of the fund. Even though most funds currently hold more than 10% liquid assets, they didn’t need to do so. Now that this is mandated, this provides an additional layer of liquidity buffer and safety,” explained Arun Kumar, Head of Research, FundsIndia.

The standardisation of an effective methodology and efficient implementation is the first set of milestones for the industry to achieve its objective. Soon, this practice can be expected to develop into a more effective guiding principle for AMCs to be able to manage liquidity risk with a higher degree of cognizance.

“Going ahead,  this norm will help AMCs strengthen their product features and offer effective risk-adjusted returns as the definition of risk becomes more comprehensive,” said Anand Dalmia, Co-founder, Fisdom.

How will this impact investors?

While there is meaningful information available in scheme documents and public sources to understand the interest rate and credit risk involved in a particular debt fund, the industry is yet to adopt a practice that allows insight into the liquidity profile.

 “If you look at most of the mutual fund schemes very closely, it can be seen that there is already more or less the same level of liquidity, and this new rule just scaffolds the intention in a formal way. It has got really nothing to do with transparency or any other matter as such, but it ensures that at any point in time investors are assured of receipt of redemption proceeds in the normal course,” pointed out Joseph Thomas, Head of Research, Emkay Wealth Management. 

 This framework defined by the Association of Mutual Funds in India (AMFI) is referred to in para 2 will take effect on December 1, 2021, for all current open-ended debt schemes (excluding Overnight Fund, Gilt Fund, and Gilt Fund with a 10-year constant duration) and schemes to be introduced on or after that date.

 “The spirit of the circular is to bring about further standardisation and communication of liquidity risk involved in debt mutual funds. We can expect the move to help debt fund investors evaluate the liquidity parameter of debt mutual funds in a better light, compare same-category funds more effectively, and finally make more informed investment decisions,” said Dalmia.