The Securities and Exchange Board of India (SEBI) on Oct 8, 2020, has stiffened Inter-scheme transfer (IST) rules for mutual funds for the purpose of ensuring safety to the investors’ interest and will be likely to be effective from January 1, 2021. SEBI has tightened MF norms on inter-scheme transfers (ISTs) by imposing certain conditions on when the facility could be used through the insertion of provisions to provide for greater accountability on fund managers deciding on such transfers.

Mutual Fund

According to SEBI, Inter-Scheme Transfers usually comprise of a scheme for buying or selling a debt instrument from another scheme of the same fund house. Such practices involve a risk to create conflicts related to valuation, a risk which was indicated by SEBI earlier too.

What do the new rules prescribe for?

i. The new rule prescribes that the ISTs for close-ended schemes will only be permissible within three business days of the new fund offer. Earlier, such transfers could be done at any time as long as the average maturity profile of the scheme was maintained.

ii. Open-ended schemes will be permitted for Inter-Scheme Transfers subject to the only condition only if all other possibilities i.e. use of scheme cash and cash equivalent, market borrowing, and selling securities in the market is exhausted only.

iii. ISTs will be permitted rebalancing to only on the crossing of regulatory limits or where duration, issuer, sector, and group rebalancing are required in both the transferor and transferee schemes.

iv. Trustees will now be obligatory to provide a mechanism to adversely influence the performance incentives of fund managers associated with the process of the Inter-Scheme Transfers in the process in credit risk schemes if the security falls in default grade after ISTs within a year. Such an impact on performance shall reflect the existing mechanism for the performance incentives of the asset management company.

v. Inter-Scheme Transfers of a security will not be allowed in case there is any negative news or alert in the conventional media about the security.

vi. Fund managers will be required to provide thorough validation to trustees for buying securities that get relegated within four months of the Inter-Scheme Transfers. The SEBI’s intent behind doing so is to protect investors and to warrant that funds do not resort to such transfers to hide bad documentation.

Where do the Current Norms stand?

The Current norms allow transfers of securities from one scheme to another scheme in the same mutual fund only in case such transfers are done at the current market price for such quoted instruments instant basis and such securities have to be in line with the investment objective of the scheme to which the transfer is intended to be made. In the case of open-ended schemes, mutual funds should have an apt Liquidity Risk Management (LRM). Model at the level of scheme, appropriated by the trustees, to secure that the adequate liquidity requirements are adequately provided for.

On the other hand, in the case of close-ended schemes, IST purchases will only be permitted within three working business days from the allotment after the new fund offer (NFO).

Nevertheless, in case of an abrupt redemption pressure, AMCs should recourse to ISTs for treatment of liquidity only after exhausting available options such as the cash and cash equivalents applications, markets borrowing, and selling of scheme securities in the market.

To meet the timeline duration, issuer, sector, and group rebalancing norms, ISTs will only be acceptable to rebalance the breach of governing limits and can be approved out if such rebalancing is required in both in transferor and transferee schemes. The market regulator has specified that different reasons cannot be quoted for transferor and transferee schemes excluding the cases where transferee schemes are a credit risk scheme.

For the purpose of guarding alongside a possible misuse of ISTs in credit risk scheme, trustees should warrant that if there is a mechanism in place to adversely influence the performance incentives of fund managers, chief investment officers (CIOs), etc. associated with the process of such transfer if the security becomes default grade with. Finally, has prohibited ISTs of security if there are negative rumors in the conventional media or an alert is generated about the security, based on internal credit risk assessment during the previous four months. In cases where such security gets downgraded within four months of IST, the fund manager of the buying scheme will provide for a detailed justification to the trustees for buying it.

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