New MTM Rules for Liquid and Debt Funds

Posted by: Uma Shashikant on Thu, Jul 1st, 2010

The Sebi circular changing the mark-to-market (MTM) rules for liquid and debt funds comes into effect today.  The summary provisions are:

a. Debt securities with less than 91 days to maturity will be valued at weighted average traded price, if traded, else on amortisation basis.

b. Debt securities with more than 91 days to maturity will be valued at weighted average traded price, if traded, else using the Crisil valuation matrix.

This means that as long as a security is traded, it has to be valued at market prices, irrespective of the time to maturity.  This is a departure from the earlier rule of allowing securities with less than 182 days to maturity to be valued on amortisation basis. The earlier rule enabled short term debt funds such as liquid funds to show a remarkably stable NAV since most of the change in NAV was from amortised interest income. The changed rules for marking-to-market have the following implications:

a. Liquid funds and cash/treasury management funds (erstwhile liquid plus funds) are likely to exhibit a higher NAV volatility than before.  The volatility may not be too high since the average maturity of these portfolios is, by construction, quite low.

b. In a liquid fund, the changes in NAV were earlier completely attributable to accrued interest income.  This enabled distribution of daily dividend and the computation of NAV every calendar day.  Now that there is an element of unrealised capital appreciation or depreciation in the NAV, this facility comes under risk.  Daily dividends cannot be distributed out of unrealised gains, and distributable surplus has to be reduced for unrealised losses.  Therefore the volatility in NAV will spill into the daily dividend and will also create capital gain or loss to investors who exit the fund.

Liquid funds had become unattractive after the 25% dividend distribution tax. Further erosion in AUM happened after the 91-day residual maturity rule. The changes in the MTM rules might take away the daily dividend and stable NAV advantages as well. The switch over to cash/treasury management funds may become higher, with this changed regime.

 Posted by Uma Shashikant on Fri, Jul 2nd, 2010 10:41:58 pm

Yes Shiraj and Sumeet,the implementation has been postponed to August 31. What is interesting is that ultra short term funds now hold nothing in treasury bills - the only instruments that trade. The CPs, CDs and the PTCs that they hold do not trade anyway.
 Posted by Shiraj on Fri, Jul 2nd, 2010 12:15:06 am

Hasn't this rule got postponed to 31st August 2010?
 Posted by Sumeet Vaid on Thu, Jul 1st, 2010 4:10:53 pm

Hi Uma Great Piece as expected kudos keep it up .Just wanted to clarify has this deadline been relaxed to 1st august or is today I heard/read it somewhere. Regards Sumeet
 Posted by Dronacharya Basu on Thu, Jul 1st, 2010 2:14:15 pm

aptly said Uma, probably some more transparency will come in-how funds are run and barring the initial hiccups, i presume, industry will evolve much stronger.

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