Sebi Limits Mutual Fund Investments in Special Debt Instruments Such as At-1 Bonds

Putting in place restrictions on the exposure of mutual funds to debt instruments with special features, securities market regulator SEBI, in a circular issued on March 10, said a mutual fund under all its schemes will not be permitted to own more than 10% of such instruments issued by a single issuer.

Presently, there are no specified investment limits for such instruments. Mutual funds invest in certain debt instruments with special features—subordination to equity or convertible to equity upon trigger of a pre-specified event for loss absorption, the circular noted. These include Additional Tier I bonds and Tier 2 bonds issued by banks under Basel III framework. These instruments are generally considered to be riskier than other debt instruments, the circular said, and hence the Securities and Exchange Board of India has put down ownership thresholds.

No mutual fund under all its schemes shall own more than 10% of such instruments issued by a single issuer. A mutual fund scheme shall not invest more than 10% of its NAV of the debt portfolio of the scheme in such instruments A mutual fund scheme shall not invest more than 5% of its NAV of the debt portfolio of the scheme in such instruments issued by a single issuer.

These investment limits for a mutual fund scheme would be within the overall limit for debt instruments issued by a single issuer as specified under SEBI’s mutual fund norms, and other prudential limits with respect to the debt instruments.

Importantly, existing investments of mutual funds in such debt instruments in excess of these new limits will be grandfathered but no fresh investment in such instruments is permitted until the investment falls below specified limits.

The step of limiting the exposure of debt funds in such instruments and putting in place restrictions on the exposure towards a particular issuer as well is a good step as it reduces the risk, said Harshad Chetanwala, co-founder of MyWealthGrowth.com. This will work in the interest of investors, he said.

Segregated Portfolio Provisions

Debt schemes which have investment in such instruments or intend to invest in them should ensure that the Scheme Information Document has provisions for segregated portfolio. The segregated portfolio will be triggered accordingly;

– If the debt instrument is to be written off or converted to equity pursuant to any proposal, the date of the proposal may be treated as the trigger date. – If such instrument is written off or converted to equity without any proposal, the date of write off or conversion of debt instrument to equity may be treated as the trigger date.

On the trigger date, Asset Management Companies may, at their option, create segregated portfolio in accordance with SEBI regulations. The financial stress of the issuer and the capabilities of issuer to repay the dues/borrowings should be reflected in the valuation of the securities from the trigger date onwards, the circular stated.

Side pocketing of such bonds with special features will allow investors the opportunity to exit the remaining part of the mutual fund scheme without giving up the chance of participating in the recovery from these instruments, Divam Sharma, co-founder of Green Portfolio, said.

SEBI also clarified that valuation of bonds with call and/or put options shall be valued in line with its September, 2000 circular, irrespective of the nature of issuer. And that, the maturity of all perpetual bonds should be treated as 100 years from the date of issuance of the bond for the purpose of valuation. Close ended debt schemes cannot invest in perpetual bonds, the regulator reiterated.

This new framework comes into effect from April 1.

Reference URL:- https://www.bloombergquint.com/markets/sebi-issues-framework-for-mf-investments-in-debt-instruments-with-special-features