In a bid to improve transparency and disclosure in debt schemes and investments by mutual funds in corporate bonds, SEBI announced certain measures on Wednesday. One, it has mandated mutual funds to undertake at least 10 per cent of their total secondary market trades by value (excluding inter scheme transfer trades) in corporate bonds through one-to-many mode on the Request for Quote (RFQ) platform of stock exchanges. Any such transaction executed by a mutual fund with another mutual fund, would also be counted for the 10 per cent requirement. Two, debt funds will now have to disclose their portfolios and yield (on instruments) information on a fortnightly basis. Currently, such disclosures are made on a monthly basis.

While the first move is aimed at improving liquidity of bonds, particularly in low-rated bonds on the exchanges, this may not yield results in the near term. Just ensuring more screen-based trading is unlikely to enhance liquidity in the AA rated and below papers, where credit risk (risk of downgrades and defaults) is an immediate concern, impeding demand. The move however, could offer more level playing field for smaller fund houses. Also, it could help address concerns over bilateral agreements entered into by certain fund houses with bond issuers in the past, leading to opacity in pricing.

While the fortnightly disclosures will be beneficial to all investors in debt funds, it would particularly help monitor credit risk in very short-term funds, such as overnight or liquid funds. Higher yield-to-maturity (YTM) in a particular fund within the category could imply investments in certain risky assets, serving as a warning signal to investors.

Through the exchange

Currently, mutual funds buy or sell corporate bonds over the phone via a broker. This reduces operational hassles for fund managers as the price negotiation is taken care by the broker. Also, given that liquidity remains a key issue for low-rated papers, brokers can help in trading of large quantities of bonds (finding buyers and sellers).

But the spate of sudden downgrades and defaults in bonds over the past three years that have impacted returns of debt funds, has led to the regulator announcing several measures to tighten risk and valuation norms for debt funds. In a bid to curb the opacity in private placement deals and prevent mispricing, SEBI has now mandated that a portion of transactions (10 per cent) by mutual funds in corporate bonds must be done via the exchange platform. This will help bring in some transparency in pricing. Also, smaller fund houses that may have been at a disadvantage earlier, owing to lower trading quantity (vis-à-vis a large fund house) executed through the broker, may enjoy a better level playing field through the exchange.

That said, how trades pan out on the platform needs to be seen. There could be some near-term procedural challenges in screen-based trading in the near term.

Also, SEBI’s intent of deepening the bond market by improving the liquidity for low-rated bonds via the exchange, would also take a long time to deliver results. Amid the pandemic crisis, downgrades and defaults are set to increase in the coming months. Low-rated bonds are likely to remain illiquid in the near term owing to weak appetite and high risk aversion among investors. As such, the absence of distressed bond market in India has been a key issue.

More disclosures

SEBI’s move mandating fortnightly disclosure of fund portfolios is a big positive for investors. Currently, while investors can monitor their funds’ portfolios on monthly basis, it may not present the complete picture on credit risk, particularly in case of very short-term funds. In case of overnight funds (which invest in overnight securities having maturity of one day) or in liquid funds (investing in debt and money market securities of up to 91 days), investors cannot assess the short-term transactions entered into by fund managers to earn high yield. Many a times, fund managers may take higher credit risk in such short-duration funds to show higher return or yield-to-maturity (YTM). A fortnightly disclosure can help investors keep a tab on such transactions and also send out warning signals if a particular fund in the category shows higher YTM than the rest in the category (indicative of investments in some risky assets).

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