On October 08, SEBI revised the guidelines related to inter-scheme transfer of securities in mutual funds, thereby imposing additional restrictions so as to improve risk management in debt mutual funds.
Presently, inter-scheme transfer (IST) of securities is permitted from one scheme to another within the same fund house, at market prices for quoted instruments on spot basis, provided such transfer is aligned with the investment objective of the transferee scheme. However, as redemption demand piled up in the aftermath of the Covid’19 pandemic, several mutual funds undertook ISTs, majorly from credit risk schemes to other schemes, to meet the liquidity crunch. In fact, around 60,000 ISTs were undertaken between March and August 2020, which in effect, resulted in the transferee schemes also being exposed to unwarranted credit risks.
Therefore, with effect from January 01, 2021, SEBI restricted ISTs in close ended schemes up to three days after allotment of the scheme’s units post a new fund offer and no further transfer is allowed. With respect to open-ended schemes, SEBI has mandated that such transfers can be undertaken to meet redemption pressure only after other attempts at increasing liquidity have been made such as, utilization of cash and cash equivalents, market borrowings and sale of scheme’s units. If the scheme level liquidity deficit persists even after implementation of such measures, outward transfers of units will be allowed through an optimal mix of low duration paper with highest quality.
Although discretion is allowed to fund managers to opt for ISTs in the interest of unit holders before availing market borrowings or sale of securities, fund managers shall record reasons for the same with evidence. Further, while fund houses can undertake inter scheme transfers transfer to avoid a breach of SEBI’s exposure limits towards a single issuer, group, sector or the overall duration limits of a portfolio, such transfer can be carried out only till the extent of such breach and no further. In such cases, it is also mandated that the reason for rebalancing shall be the same for both the transferor and the transferee schemes, unless the transferee scheme is a credit risk scheme.
Additionally, trustees of the mutual fund shall put in place a mechanism to negatively affect the performance incentives of fund managers and chief investment officer involved in ISTs with respect to credit risk schemes, if the security becomes default grade within one year from the date of the transfer. Further, no IST will be allowed if there is any negative market news or rumour in mainstream media or an alert is generated in respect of a security based on the internal risk assessment of the mutual fund during the preceding four months.
In the event a security gets downgraded within four months from the transfer, fund managers will be required to furnish a detailed explanation to the trustees as to why the transfer was undertaken. Further, SEBI has also provided a template for recording of reasons for rebalancing and the details of attempts made to meet the liquidity deficit prior to an IST.
The above stringent norms would not only make ISTs more difficult, but fund houses would need to put in place better risk management systems and ensure that they have enough liquidity so that frequent ISTs can be avoided. The above norms also mean that liquidity management will now be required to be implemented at the scheme level and not only at the fund level.
