The Securities and Exchange Board of India (Sebi) said on Saturday it was tightening the valuation norms for liquid funds.

At the board meeting on Saturday, the regulator decided to amend the Sebi Mutual Fund Regulations to bring down the threshold for marked-to-market (MTM) requirements on debt and money market securities to 60 days from 91 days.

“In case debt and money market securities are not traded on a particular valuation day, then valuation through the amortisation basis shall be restricted to securities having residual maturity of up to 60 days (currently 91 days), provided such valuation shall be reflective of the realisable value/fair value of the securities," Sebi said in a release after the meet.
 

A Balasubramanian, chief executive of Birla Sunlife Mutual Fund, said the date of implementation needed to be watched out for. “The move was expected. We need to watch out for the date. Usually, sufficient time is given. Most liquid funds’ average maturity is around 60 days, so the impact may not be much," he said.

Fund managers said the move would enable equal treatment of all investors. At present, if there are huge redemptions and if the fund house liquidates securities at losses, the person who redeems is benefitted at the expense of ones who stay invested.

“Short-term rates are volatile. If an investor decides to exit at some point, if he is out of the money due to a rise in rates, other investors will be left bearing the losses. I believe the MTM has to be brought to Day One," said a fixed income head.

The regulator said asset managers should ensure fair treatment “to existing investors as well as to investors seeking to purchase or redeem units of mutual funds at all point of time in all schemes."

Analysts said the move to extend the MTM to instruments of shorter tenure would reduce systemic risk. Without it, funds were giving an implicit guarantee to investors of a certain rate of return. But unlike banks, they do not have the capital backing.

Dhirendra Kumar, chief executive of Value Research, said, “Fund net asset value (NAV) will be volatile. As they are valued today, I do not think there will be any significant outflows from liquid funds."

Liquid funds, as the name suggests, allow quick entry and exit to investors and typically, invest in money market instruments such as certificate of deposit (CD), commercial paper (CP) and treasury bill. For securities with a tenure of less than 91 days, there is no MTM. As CDs and CPs are not actively traded on exchanges, prices are not transparent. Therefore, funds follow the amortisation method, where returns are prorated over the tenure of the instrument. This results in stable NAVs.

Corporates and banks have been using liquid funds as a cash management tool, since they are guaranteed of three-four per cent returns. Due to the amortisation method used now, they do not experience volatility in the portfolio up to 90 days. But this was an illusion created by the method, which could get exposed in extreme events like the Lehman collapse, experts said.

Srinivas Jain, chief marketing officer, SBI Mutual Fund, said, “We have to wait and watch how this turns out. How the valuation matrix for investors works out need to be seen, as there will be an element of volatility."

The MTM valuation for money market and liquid instruments was introduced in July 2010, to avoid a repeat of the liquidity crisis in 2008, following the collapse of Lehman Brothers. However, this was limited to instruments with residual maturity of 91 days or more. As a result of this rule, many fund houses booked heavy losses in FY11.

The Reserve Bank of India and the capital market regulator have repeatedly expressed concerns about banks and corporates round tripping investments using liquid funds. Fund houses have lost significant money in liquid funds since RBI capped banks’ investments in liquid funds at 10 per cent of their networth in May.

According to the Association of Mutual Funds in India, assets under management of liquid and money market schemes nearly halved to Rs 1.2 lakh crore, or 20 per cent of the industry, in December. At the end of April 2011, liquid funds managed Rs 2.2 lakh crore, 28 per cent of the industry.