The Securities and Exchange Board of India (Sebi) is probing whether mutual funds cut token bond deals with each other to prop up scheme returns. The capital markets regulator has asked fund houses to submit details of the recent trades in debt papers including Inter Scheme Transfers and ones that led to a mark-up in bond valuations, said two people familiar with the matter.
Sebi’s move comes in the wake of allegations that funds do friendly deals with each other to boost or suppress valuations of debt papers in their favour. Unlike equity schemes, which follow stock prices on exchange platforms, debt schemes do not have a uniform valuation for bonds. One mutual fund could value a debt security differently from another but within a band.
This is how it works. A debt scheme holding securities worth Rs 500 crore of a company wants to lift its overall net asset value (NAV). For this, the fund house would strike a deal with an industry peer to buy a small portion of its holdings. The transaction could be worth as little as Rs 5 to Rs 10 crore, but it would be done at a higher price than its current level. The token deal, say of Rs 5 crore, would help the fund house, which sold the paper, mark up the value of its remaining holdings of Rs 495 crore. Sebi rules allow debt schemes to value papers based on the last transactions. To return the favour, the selling mutual fund could conduct a similar trade in another paper that the friendly fund holds. In industry parlance, it is called ‘self-trades’ or ‘own trades’.
The regulator wants to know whether fund houses are trading among themselves with the sole intention of altering the valuation of the security.
“Many mutual funds do self-trades to reprice their entire portfolio,” said the chief executive officer of a mid-sized mutual funds. “It is a grey area because the intention is to move the valuation of security in a favourable way.”
Majority of the so-called self-trades are happening in securities such as commercial papers with maturity below 30 days. Liquid funds mostly invest in such securities. Some funds are also doing these trades in longer-term papers also. Sebi will also look into the Inter Scheme Transfers, a process of moving debt securities between schemes within the same fund. Though such transfers are allowed, Sebi has frowned upon the practice fearing its misuse.
Industry officials said the regulator has received complaints that self-trades in debt securities have been done to benefit some large investors. “There is a need to bring in much more transparency into the debt market deals by mutual funds. A lot of the practices are being misused,” said a senior mutual fund official.
The managing director of another mutual fund said valuation norms should be uniform across mutual funds, insurance companies and banks.
Source: Economic Times