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The Reserve Bank of India has expressed concern over the concentrated portfolios of mutual funds, and has urged capital market regulator SEBI to consider investor-level concentration limit on the issuer to ensure diversification at the issuer-level.
To ensure a diversified portfolio, the Securities and Exchange Board of India has put in place various safeguard measures, including single issuer limit, group exposure limit, and sector exposure limit on mutual funds. These limits are constantly revised to ensure that the portfolios of mutual funds remain diversified.
In this regard, the RBI, in its latest Financial Stability Report released on Friday, said it might be appropriate to consider investor-level concentration limit on the issuer to ensure diversification at the issuer-level. To improve liquidity in money market and liquid funds, valuation and maturity restrictions are under review by SEBI. A mandatory liquidity limit may also be considered by them.
In this regard, an effective asset-liability management (ALM) regime in the non-banking financial sector may also enhance systemic resilience, it added.
Risk to deepening market
The deepening and broadening of the financial markets also has some inevitable side effects in terms of greater inter-connectedness and potential contagion effect. There needs to be further coordination among the regulators to identify possible regulatory arbitrage opportunities on account of regulatory gaps, or perceived and real informational asymmetries among the regulators, said the RBI. On the other hand, the balance between market development, a desirable level of credit discipline and greater oversight are crucial for a sustainable and stable financial system and to maintain inter-generational equity.
Fair value of corp issuances
Some of the emerging issues include valuation of credit instruments, which require two prerequisites: an arbitrage-free sovereign pricing curve, and transparent corporate spreads specific to the tenor and rating.
A portfolio of corporate bonds that does not reflect the fair and exchangeable value of the underlying assets fails to serve as a barometer for the health of the issuer. Moreover, it can also potentially impose externalities on the rest of the market when investors prefer a flight to safety as discrepancies in valuations get discovered.
In addition, a wedge between primary market price discovery and internal carrying cost of equivalent securities may potentially act as a disincentive to trade in underlying securities. There is also the possibility of it resulting in a weak price discovery mechanism.
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