India’s mutual fund body has asked the market regulator to allow fund houses to use intraday borrowings from banks to purchase securities after it deferred implementation of the new norms to July, according to two people aware of the development.
On 13 March, the Securities and Exchange Board of India (Sebi) tightened regulations and allowed fund houses to borrow funds from banks on an intraday basis only for repurchase or redemption of units, payment of interest, or income distribution-cum-capital withdrawal payouts to unitholders. The new rules were to have become effective on 1 April, Sebi said in a circular.
“The circular will tie up mutual funds’ hands. Mutual funds have told the Association of Mutual Funds in India (Amfi) and Amfi is talking to Sebi about this,” one person said.
The regulator permitted such borrowing without an upper limit on the condition that it is backed by guaranteed same-day receivables from maturity proceeds from government securities such as Treasury Bills Repurchases (TREPS) and G-Secs.
However, in a follow-up circular on March 25, Sebi deferred the implementation of the intraday borrowing guidelines to 15 July, citing “operational challenges” raised by asset management companies (AMCs). The deferral gives the regulator and fund houses a window to revisit the new rules.
The restriction had unsettled AMCs, which used intraday borrowings to also fund purchase of securities. Under the prevailing practice, especially in liquid and overnight schemes, redemption payouts to investors are made on the morning of T+1, while maturity proceeds from TREPS and reverse repos are received only later in the evening.
To bridge this intraday mismatch between inflows and outflows, mutual funds rely on formal intraday borrowing arrangements with banks and other financial institutions.
“Amfi is discussing the matter with Sebi, but the regulator needs time to recraft the circular and has hence put the circular in abeyance. Mutual funds have also discussed the matter with Sebi. This has created some chatter in the industry as to how mutual funds will buy securities without cash in hand,” the second person said.
A mutual fund executive, speaking on condition of anonymity, said the issue is less about leverage and more about timing.
“Clarity from Sebi on whether AMCs can borrow intra-day to buy securities will be appreciated. CCIL (Clearing Corporation of India Ltd) both receives and pays the money – when you buy TREPs, you pay them, and when TREPs matures, they pay you – both are on the same day, but the paying and payout time tends to be different,” the executive said.
The concern is that if borrowing is not permitted for purchases, funds may have to wait until cash is credited before deploying it, even if the inflow is contractually assured on the same day.
“If AMCs don’t deploy the money at the right time and buy the security (debt-related), they will lose out on one day’s interest and the security cannot be bought if money doesn’t come in on time,” the executive added.
Fund managers said this could disrupt portfolio strategies, particularly around non-banking days or market holidays.
“When markets are down and people stop their SIPs, mutual funds may not have adequate liquidity for redemptions. Sebi allowed intra-day borrowing for redemptions to ensure this does not happen,” said Sidharth Kumar, a senior associate at BTG Advaya, a law firm.
However, he noted that allowing intra-day borrowing for purchase of securities comes with its own risks.
“If mutual funds purchase securities with borrowed money and the market takes a bad turn, there might be a credit risk as they lose out on asset value,” Kumar said.
The credit risk can become systemic and may be the reason why Sebi allowed intra-day borrowing only for redemptions, Kumar said.
The March circular said that such borrowing must be backed by receivables due the same day from entities such as the government, the Reserve Bank of India, or the CCIL, and that any associated cost must be borne by the AMC, not the scheme.
The debate comes amid broader regulatory recalibration. The RBI on March 30 extended the implementation timeline for its amended capital market exposure norms by three months to July. These norms covered bank financing of acquisitions by Indian companies, lending by banks to individuals against securities and lending to capital market intermediaries.
One clarification by the banking regulator was that intraday borrowing by non-debt mutual funds, when backed by assured same-day receivables such as maturities of G-Secs, will not be classified as capital market exposure. This puts Sebi’s circular in tandem with RBI norms.
Emailed queries to Sebi and Amfi did not elicit responses.