SEBI issues guidelines for emergency facility for debt funds in unfavourable market conditions

CDMDF is a corpus that will buy debt securities from mutual fund houses and give them cash to ensure that redemptions don’t stop.

Nearly four months after it was announced, the capital market regulator Securities and Exchange Board of India (SEBI) issued detailed guidelines on the much-awaited Corporate Debt Market Development Fund (CDMDF).

This comes a day before finance minister Nirmala Sitharaman will formally launch the fund in Mumbai. This fund will work as a backstop facility for debt mutual funds by buying investment-grade corporate debt securities held by debt mutual fund schemes in times of market dislocation. Here’s what it means.

How does CDMDF work?

CDMDF is a corpus that will buy debt securities from mutual fund houses and give them cash to ensure that redemptions don’t stop. As per SEBI guidelines, it will be a closed-ended scheme with an initial tenure of 15 years, which can be extended later. In normal circumstances, it will invest only in short-duration government securities, treasury bills, tri-party repo on government securities and guaranteed corporate bond repo with maturity not exceeding seven days. During normal times, the fund will charge an expense of 15 basis points (bps) plus taxes. In times of market stress, the charge goes up to 20 bps plus taxes. Expenses include brokerages and clearing charges.

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When a debt crisis hits and the CDMDF is activated, it will then buy debt securities from debt mutual funds. Here, it would buy only investment-grade listed corporate debt securities, including listed money market instruments. Only securities with less than five years of residual maturity will be bought. The long-term credit ratings of the corporate bonds will prevail over short term ratings. The fund will follow a conservative approach while ascertaining the credit rating of an instrument, when long-term ratings are not available. SEBI has also clearly specified guidelines on the purchase and valuation of securities by CDMDF in times of stress.

CDMDF will disclose the net asset value by 9.30 pm on every business day. In times of market dislocation, when it is holding corporate debt, the same should be announced by 11 pm of the business day.

Where will the money come from?

Barring gilt funds and overnight funds, debt schemes (including conservative hybrid schemes) of mutual fund schemes will invest a corpus equivalent to 25 bps of their assets under management (AUM) in the units of CDMDF. Every six months, these schemes must contribute incrementally if there is an increase in AUM. Such half-yearly contributions begin from December 2023 onwards, which shall be made within 10 days from the end of each half-year, failing which the asset management company is expected to pay an interest at the rate of 15 percent.

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Once the fund house contributes to this corpus, it cannot take its money back, even if the scheme’s own AUM decrease.

All mutual fund houses are asked to make a one-time contribution of CDMDF at the rate of 2 bps of the AUM of aforesaid debt schemes. New fund houses will also contribute such a one-time contribution at the rate of 2 bps of the AUM in specified debt schemes at the end of the first financial year.
In times of stress, as defined by SEBI, if a fund house decides to sell a corporate listed debt security to CDMDF, only 90 percent of the consideration will be paid in cash to the fund house and the rest will be paid in terms of units of CDMDF. These units will bear the first loss, if the security sold to CDMDF causes a loss to CDMDF. Such units can be sold during the tenure of the scheme subject to certain conditions.

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“The respective mutual funds shall have access to sell corporate debt securities during market dislocation, held in the portfolio of contributing schemes, to the CDMDF. Access to the fund shall be in proportion to the contribution made to the fund at a mutual fund level—that is, in the ratio of total units of CDMDF held by all specified debt schemes of each mutual fund,” said the circular.

The fund houses are told to make necessary changes to their scheme documents to incorporate details of such contributions to CDMDF. However, such changes will not amount to the fundamental attributes of the scheme. Also, contributions to CDMDF and units allotted to schemes will not be considered while computing potential risk class matrices or violations to asset allocation guidelines around maturity restrictions.

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SEBI has further reiterated that these provisions pertaining to CDMDF come into force with immediate effect. Debt mutual fund investors thus have one more layer of security for their investments in debt funds, especially in times of stress.