Credit Risk-Based Single Issuer Limit for MFs Investment: SEBI

Nikhil Mogha

22 May, 2024

The Securities & Exchange Board of India issued the circular “Introduction of credit risk-based single issuer limit for investment by mutual fund schemes in debt & money market instruments” on 29^th November 2022 in the exercise of powers under clause 1 of Section 11 of the SEBI Act 1992 r/w Regulation 77 of SEBI (Mutual Funds) Regulations 1996. The current circular has notified the credit risk-based single issuer limits, which shall be followed by the Mutual Funds while investing in the debt and Money market instruments. The introduction of credit risk-based single issuer limit shall apply to the actively managed mutual funds scheme. The present article will discuss the changes and the reason for such changes.

What Is The Previous Investment Limit For Money Market And Non-Money Market Securities?

In accordance with Regulation 44(1) r/w Clause 1 of the 7^th Schedule of SEBI (Mutual Funds) Regulations 1996, the mutual funds scheme should not invest more than 10% of its NAV or Net Asset Value in debt instruments which are issued by a single issuer for the money market and non –money market securities that are rated investment grade or above by CRR or Credit Rating Agency. However, the limit of 10% can be extended to 12% of the Net Asset value of the scheme subject to approval by the board of trustees and board of directors of Asset Management Company (AMC).

In addition to the limit mentioned above, the circular of SEBI on “Development of Passive funds” has introduced the credit risk-based single issuer limit for debt Exchange Traded Funds and Index Funds with the aim to manage the risk associated with such investments effectively.

What Is The Reason For Introducing Credit Risk Based Single Issuer Limit For Debt And Money Market Instruments?

The reason for introducing a credit risk-based single issuer limit is to avoid any inconsistency in the investment by Mutual Funds in debt instruments of the issuer, irrespective if the scheme is actively or passively managed. Therefore, in pursuance of this, it is decided by SEBI to issue a similar credit risk-based single issuer limit for an actively managed Mutual Funds scheme.

What Are The New Credit Risk Based Single Issuer Limit For Debt And Money Market Instruments?

In addition to the limits specified in Clause 1 of the 7^th Schedule of SEBI (Mutual Funds) Regulations 1996, the following prudential limits shall be followed for the schemes other than credit risk funds:

a. A mutual fund scheme should not invest more than:

1. 10 % of its NAV(Net Asset Value) in Debt & Money market Instruments rated AAA
2. 8% of its Net Asset Value in Debt & Money Market Instruments rated AA
3. 6% of its Net Asset Value in Debt & Money market instruments rated A and below.

Issued by a single issuer.

Extension of Limits: The limits mentioned above can be extended by upto 2 % of the Net Asset Value^[1] of the scheme subject to prior approval from the board of trustees and board of Directors of AMC, provided the said limit does not extend more than 12% of the limit specified in the Clause 1 of 7^th Schedule of SEBI (Mutual Funds) Regulations 1996.

How Will Long-Term Rating Take Place In The Money Market Instruments?

In money market instruments, the long-term rating of the issuer shall be considered; however, in case if there is no long-term rating yet available for the issuer, then, in that case, it shall be based on the credit rating mapping of Credit Rating agencies between short and long term ratings and the most conservative long-term rating shall be taken for the given short-term rating.

Moreover, any exposure to government money market instruments, including TREPS on government securities (G-Sec) or treasury bills, shall be treated as exposure to government securities.

What Is The Effective Date For The Circular On Credit Risk Based Single Issuer Limit For MFs Investment?

The circular on Credit risk-based sing issuer limit for MFs Investment in debt and money market instruments shall apply to all the new schemes launched with effect from the issuance of this circular, i.e. 29^th November 2022. However, the limit enumerated under the circular is exempted for the existing schemes till the maturity of the underlying debt & money market instruments.

Conclusion

The Securities & Exchange Board of India has declared that the Credit risk-based Single issuer limit for MFs Investment in debt and money market instruments shall be followed by schemes other than the credit risk funds. Further, the circular has defined different values on Net Asset Value for different ratings. The circular also provides leverage to the given rating of mutual funds schemes in the investment by providing 2% leverage in the Net Asset value. Therefore, the new rating shall be effective from the issuance date of the circular.

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