Sebi proposes net settlement of funds for mutual fund cash market trades

The Securities and Exchange Board of India (Sebi) on Thursday proposed allowing mutual fund schemes to settle funds on a net basis for cash market transactions while continuing to settle securities on a gross basis. The move is aimed at easing temporary liquidity requirements and improving settlement efficiency for mutual fund schemes. 

The proposal follows representations from market participants, who pointed to liquidity pressures and operational inefficiencies arising from fund obligations being met on a gross basis at the scheme level. These issues can become more pronounced during index rebalancing, when passive funds have to make significant portfolio changes, as well as during periods of large investor subscriptions and redemptions. 

What is the proposed framework? 

Sebi said the proposed framework would improve ease of doing business while retaining existing safeguards around delivery-based settlement, scheme-level accounting, valuation, and investor protection. 

Under the proposal, net settlement of funds would be permitted only for outright buy or sell transactions undertaken by an individual mutual fund scheme in the cash market through a recognised stock exchange. 

Importantly, Sebi has proposed that netting would be restricted to the individual scheme. Transactions across different schemes managed by the same mutual fund would not be allowed to be netted against each other. 

The asset management company (AMC) and the custodian would be responsible for ensuring that the arrangement does not affect scheme-wise accounting, valuation, daily net asset value (NAV) calculations, segregation of securities and funds, or unit-holder interests. 

Funding obligations 

Sebi has also laid out how funding obligations would be handled when purchase and sale values differ. If the value of outright sales is lower than the value of outright purchases, the mutual fund scheme would have to fund the shortfall, along with purchase obligations arising from non-outright transactions. 

On the other hand, if outright sale proceeds exceed outright purchase values, the excess amount cannot be used to meet purchase obligations arising from non-outright transactions, according to the proposal. The regulator said the framework follows its earlier decision to allow net settlement of funds for foreign portfolio investors (FPIs). 

The Association of Mutual Funds in India (AMFI) has been proposed as the body responsible for framing implementation standards in consultation with custodians, clearing corporations, stock exchanges and other stakeholders. These standards could cover the treatment of partially confirmed or rejected trades, reporting and file formats, reconciliation, exception handling, audit trails, and scheme-level controls. 

Sebi has invited public comments on the proposal until September 24. The regulator will consider the feedback before deciding on the final framework. The proposed changes are expected to reduce the need for mutual fund schemes to maintain additional short-term liquidity for settling cash market trades, while keeping securities settlement and scheme-level controls unchanged.