Now Mutual Funds Investment May not be Desirable Source of Capital for Firms and NBFCs

Tanya Verma

06 Aug, 2021

On 27^th June 2019 Securities and Exchange Board of India {SEBI} announced that now the rules for mutual funds investments will be tougher for borrowers to make deals with Fund Managers to raise capital. The new rules will surely decrease the attractiveness of Mutual Funds Investments as a source of extracting capital for firms and NBFCs. In this blog, we are going to see how these rules will affect the mutual funds investment and what can be adapted as a replacement.

What is Main Role of SEBI in regulating Mutual Funds Investment

The Securities and Exchange Board of India {SEBI}^[1] is a regulatory body which is appointed to look upon the financial matters and markets in India. The primary functions of SEBI include;

• Protecting the interests of investors in securities
• Promote and regulate the securities market
• Making rules which makes aware of the functioning of mutual funds by providing related information etc.

The roles of SEBI in mutual funds investment are as follows;

• It is the regulatory body which formulates policies for mutual funds
• It makes rules to bring uniformity in the functioning of all the mutual funds
• The body categorizes its regulations into the following schemes to standardize the rules on which the mutual funds work;
  • Equity
  • Debt
  • Hybrid
  • Solution oriented schemes
  • Other schemes
• This broad categorization ensures mutual funds have only one scheme under each sub-category.
• Also, categorizing helps in simplifying the norms under which mutual funds are selected and work in retaining the interest of investors
• Mutual funds act as a major source of gaining capital for various organizations and also NBFCs. SEBI sets guidelines for that also

Read our article:All you need to know about SEBI’s Insider Trading Regulations

Earlier practices of mutual funds investments under SEBI guidelines

Mentioned below are the earlier practices before the changes made in this board meeting and it’s after effects;

• Only the bonds maturing after 60 days was valued at the market price this was changed to 30 days in the amendment
• Earlier the liquid funds were not that transparent introduction of MTM will now make that more transparent to the public
• The liquid funds must hold 20% in liquid assets like cash or equivalent which earlier was 10%
• Furthermore, now the liquid funds will launch a “graded exit load” which will be levied on the investors who leave the fund within seven days. This will minimize the effects of lumpy inflows and outflows
• Now the liquid and overnight funds will not be allowed to invest in short term deposits, debts and specific money market instruments
• The sector caps for liquid funds are further tightened. Now the exposure to a single sector will be limited to 20% which was 25% earlier. This will reduce the risks associated with these funds

Updates of the SEBI Board and Rules Regarding Mutual Funds Investment

The board meeting of SEBI held in Mumbai on 27 June 2019 came up with the following conclusions at the end of the meeting.

The Schemes were defined in six points:

• The framework for the issuance and listing of Differential Voting Rights {DVR} Shares was set. Under this the following proposals were approved;
  • • A company possessing Superior Voting Rights Shares {SR Shares} will be allowed to do the initial Public Offering {IPO} of the ordinary shares only that is to be listed on the Main Board. This is related to fulfillment of eligibility requirements of SEBI rules, 2018 under the prescribed conditions
    • SR Shares need to be listed on stock exchanges after the issuer company makes a public issue. However, the SR Shares will be in a lock-in state after issuing the IPO until it is converted to ordinary shares
    • The total voting rights of SR Shareholders including the ordinary shares and post listing should not be more than 74%.
    • The companies having SR Shareholders will be under Enhanced Corporate governance as per prescribed conditions
    • The SR Shares will be considered as ordinary equity in relation to voting rights under the specified conditions
• SEBI Regulations, 2015 now prescribe that during a financial year the payments to concerned parties for brand usage the royalties will be considered material if the transaction amount is more than 2% of annual consolidated turnover
• The board has approved matters related to the disclosure of encumbrances
• The standards were reviewed relating to the risk management framework of liquid funds, investment norms and valuation of money market and debt securities by mutual funds. This was done to secure and maintain the orderliness and robustness of Mutual Funds Investment;
• Also, amendments were made to the SEBI {PIT} Regulations which clarifies that the trading window closure for listed companies will be applicable from end of every quarter to 48 hours after the declaration of financial results
• Also, the board approved the SEBI Annual Report 2018-19 under Section 18(2) of the SEBI Act, 1992. This report will be submitted to the Central Government

Read our article:New Guidelines on Liquidity Risk Management framework for NBFCs

How will new categorization affect an investor?

This scheme is designed to help the investors in the following ways;

• It will reduce the number of schemes on offer and will make it easier to choose them
• There might be a scheme combined with other schemes
• It may lead to falling off your expense ratio due to increase AUM per scheme

Conclusion

The change in the regulations for mutual funds investments has tightened under which the mutual funds function. Various rules such as graded exit load increased security for credit enhanced securities, and an increase in capital allocations in liquid assets might lead to confusion for the investors and also can make the process complex. This may cause borrowers like firms and NBFCs to preferring other sources of capital like alternative investments funds and high net-worth individuals.