SEBI Announced New Norms For Mutual Funds

SEBI Announced New Norms For Mutual Funds

Recently, SEBI announced a major change in mutual funds investment. Now multi-cap mutual funds have a compulsion to invest 25% each in mid, large, and small capitalization funds. Let us demystify what multi cap, large cap, mid cap, etc are and understand how mutual funds and investors will be impacted by this move.

Crux of the Matter

Before you deep dive into this piece, you can understand the basics of Mutual Funds in a simple jargon-free language here.

Recent Announcement
SEBI made it mandatory for multi-cap Mutual Funds to invest at least 25% of their funds in each small, mid, and large-cap equities. Mutual funds have been told to abide by the new rules by end of January 2021. A multi-cap mutual fund is the one that invests across equities with varied market capitalization, i.e. large-cap, mid-cap, and small-cap. Market Capitalisation = Share price x Number of outstanding shares.

Currently, minimum equity allocation in multi-cap is 65% but as per the new rule minimum equity allocation will also increase to 75%.

Impact
Experts say that investors who have already invested in mid and small-cap funds will be benefited. As demand for mid and low cap stocks increases, so will their price. Investors’ holdings in mid and small-cap, thus, can go up due to accelerated buying in mid and small-cap space by the multi-cap funds before January 2021.

Response Strategy
Investors can switch their funds from multi-cap to other equity funds. Mutual Funds can merge/dissolve multi-cap funds with large-cap funds or large-mid cap funds. One can also convert multi-cap to ESG (Environmental, Social, and Governance) funds. By doing so one can maintain the same investment process as well as portfolio quality. ESG funds measure the sustainability and ethical impact of an investment in a business or company in Environmental, Social, and Governance areas. ESG criteria are often preferred by socially responsible investors for investments.

Curiopedia
  • An index fund is a mutual fund designed to follow certain preset rules so that the fund can track a specified basket of underlying investments. The first theoretical model for an index fund was suggested in 1960.
  • Dollex 30 is the USD version of the SENSEX. It is designed to measure the performance of the 30 largest, most liquid and financially sound companies across key sectors of the Indian economy that are listed at BSE Ltd.
  • The first modern investment funds were established in the Dutch Republic. In response to the financial crisis of 1772–1773, Amsterdam-based businessman Abraham van Ketwich formed a trust named Eendragt Maakt Magt (“unity creates strength”).

What Caused Havoc On The Stock Exchange?

What Caused Havoc On The Stock Exchange?

The Securities & Exchange Board Of India (SEBI) implemented new margin and share pledging norms from 1st September. It has taken the step after several incidents of misuse of client funds were reported. Let’s have a look at the changes and its consequences that lead to, for the first time in history, disruption in the functioning of the stock exchange.

Before you delve into the story, if you want a layman understanding of the financial jargon like margin, intraday, leverage, etc, click here.

Crux of the Matter

What Are The Changes?

  • Traders must keep a higher margin in their accounts to receive the same leverage as before.
  • Brokers not allowed to extend any higher-margin limit than prescribed.
  • The required margin must be paid (by client) or collected (by broker) within T+1 (for derivatives) and T+2 (for equities and commodities).
  • Clearing corporations will impose a penalty if the broker fails to collect, or the client fails to pay.
  • Now clients’ trades will be carried out directly with the Clearing Corporation. It is associated with exchanges to handle the confirmation, settlement, and delivery of transactions.
  • Clients need a minimum margin at the beginning of the transaction as compared to required at the end of the day before.
  • Most importantly, traders will not be able to utilize funds from the selling of shares for 3 days from trading.
  • Now onwards, intraday profit cannot be used to buy new shares.

Experts say that the new margin rules aim to safeguard retail brokers who fail to manage margin leverage.

Another Reason For Change – Misuse of PoA
Previously, brokers used to give margin if the client pledged shares or signed the Power
of Attorney
(PoA). Now brokers will not have power of attorney over their clients’ Demat account. Earlier, some brokers were using one client’s assets as margin collateral for another client who was likely short of funds.

In the past Karvy Stock Broking Ltd. illegally transferred investments of 95,000 clients to its own account and pledged without any authorization. Similarly, brokers misused the PoA assigned to them.

Immediate Chaos
National Stock Exchange (NSE) could not process clearing and settlement for the first time in history on 1st September 2020. Overloading of orders choked the Clearing Corporations’ systems.

SEBI says that chaos happened as brokers waited till the last minute to pledge and re-pledge large quantities of shares. Whereas brokers pointed fingers at the lack of preparation from the depository to implement new changes. In an interim relief to investors, brokers, and the system, SEBI stopped exchanges from imposing fine till 15th September for not paying margin.

Curiopedia
  • The 1992 Indian stock market scam was a stock market scam orchestrated by Harshad Mehta. The scam was the biggest stock market scam ever committed in the Indian Stock Market. It was a systematic stock fraud using bank receipts and stamp paper which caused the Indian Stock market to crash.
  • Popularly referred to as the “Warren Buffett of India”, Rakesh Jhunjhunwala is an Indian businessman and investor. He is the 48th richest person in India, with a net worth of $2.5 billion.
  • The Big Bull is an upcoming Indian Hindi-language biographical crime film based on Harshad Mehta’s life involving his financial crimes over a period of 10 years, from 1980 to 1990. It stars Abhishek Bachchan as Mehta.

SEBI Changes Margin Requirements for Cash and Derivatives Trading

Sebi

After making changes to the margin framework for commodity derivates in January 2020, Market Regulator SEBI has made amendments to the margin requirements in the cash and derivates segment.

Crux of the Matter

Market Watchdog Securities and Exchange Board of India (SEBI) has amended the margin framework for derivatives and cash segments, a move aimed to enhance the risk management system. SEBI’s Risk Management Review Committee has outlined that the changes are in tandem with the dynamic nature of the market and that it will increase efficiency in the market.

With respect to the Cash Market, SEBI divided the Value at Risk (VaR) margin rates on the basis of liquidity into three categories.

For the Derivates segment, SEBI updated the calculation of volatility, calendar spread charge on various products, extreme loss margin, the margin on consolidated crystallized margin and minimum charge on short option.

There shall be no separate short option minimum charge for index derivatives, single stock derivatives, currency and interest rate derivatives.

– SEBI on charges on Short Option

Most importantly, Sebi put these provisions of upfront additional margin for stocks that are highly volatile.

1. Securities that have an intra-day price movement of more than 10% on the basis of the formula, Maximum of (High-Low), (High-Previous Close), or (Low-Previous Close) for 3 or more days in the preceding 1 month in a particular stock market will attract a minimum total margin equal to the maximum intra-day price movement in the respective market in a month. “This shall be applicable till the monthly expiry date of the derivative contract which falls after completion of three months from the date of levy,” as per SEBI.

2. Securities that have an intra-day price movement of more than 10% on the basis of the formula, Maximum of (High-Low), (High-Previous Close), or (Low-Previous Close) for 10 or more days in the preceding 6 months in a particular stock market will attract a minimum total margin equal to the maximum intra-day price movement in the respective market in 6 months. “This shall be applicable till the monthly expiry date of the derivative contract which falls after completion of one year from the date of levy,” as per SEBI.

The changes will be applicable from May 1, 2020.

Curiopedia

Margin (Finance) is collateral that the holder of a financial instrument has to deposit with a counterparty (most often their broker or an exchange) to cover some or all of the credit risk the holder poses for the counterparty. This risk can arise if the holder has done any of the following:
– Borrowed cash from the counterparty to buy financial instruments,
– Borrowed financial instruments to sell them short,
– Entered into a derivative contract.
The collateral for a margin account can be the cash deposited in the account or securities provided, and represents the funds available to the account holder for further share trading. More Info

Mutual Funds, AIFs to Follow Stewardship Code: SEBI

In a move to enhance Corporate Governance of the Investee Companies, Securities and Exchange Board of India (SEBI) announced that Mutual Funds (MF) and Alternative Investment Funds (AIF) will compulsorily adhere to the Stewardship Code from April 1, 2020. The code will require institutional investors to formulate new policies to enhance transparency and their role in the Financial Market.

Crux of the Matter
  • SEBI, in co-ordination with IRDA and PFRDA, got approval from the Financial Stability and Development Council to implement the stewardship principles in India.
  • Fundamentally, the institutional investor will have to formulate policies for stewardship responsibilities and dissemination of information to the public.
  • It is also required for companies to have a code implemented to manage conflict of interest.
  • The Code will also require institutions to regularly monitor their investee companies, their performances, corporate governance policies, risk management policies, etc. and to seldom intervene if the situation – like poor performance, corporate governance issues, leadership problems, litigation, etc. – demands.
  • Moreover, institutional investors will be required to have a detailed voting policy. It may contain rules and regulations on mechanisms of voting, proxy voting, and when to eschew from voting.
Curiopedia

The Stewardship Code is a part of UK company law concerning principles that institutional investors are expected to follow. It was released in 2010 by the Financial Reporting Council, and is directed at asset managers who hold voting rights on shares in United Kingdom companies. Its principal aim is to make institutional investors, who manage “other people’s money”, be active and engage in corporate governance in the interests of their beneficiaries (the shareholders). India’s Stewardship Code has its root in the seven guiding principles of the UK Code. More Info

India's Biggest Lender, SBI Under-Reported INR 12k Crore of NPAs

In a filing to SEBI, State Bank of India stated that it had underreported bad loans of INR 11,932 crores in the last fiscal year. RBI directed that the bank will have to provide for additional bad loan provision, which in turn will show a loss of INR 6,968 crore in the books of SBI.

Crux of the Matter
  • RBI, in its review, noted that the State Bank of India had not reported INR 11,932 crores of non-performing assets (NPAs).
  • SBI’s reported gross NPA of INR 1,72,750 crores will have to be increased to INR 1,84,682 crores.
  • As a result, SBI will have to provision INR 12,036 crores for bad loans.
  • The balance sheet profit of FY 18-19 INR 86 crore will be reduced to a loss of INR 6,968 crores.
Curiopedia

A non-performing loan (NPL) is a loan that is in default or close to being in default. Many loans become non-performing after being in default for 90 days, but this can depend on the contract terms. In India, non-performing loans are common in the agricultural sector where the farmers can’t pay back the loan or the interest amount mainly as a result of losses due to floods or drought. More Info