Explained: Why Sebi's intraday borrowing rules for mutual funds don’t mean higher risk for investors

The Securities and Exchange Board of India (Sebi) has approved a key change to mutual fund liquidity rules by relaxing the framework governing intraday borrowings. The move allows asset management companies (AMCs) to access short-term bank borrowings for a wider set of operational purposes beyond investor redemption payouts.

The decision is aimed at improving cash-flow management and operational flexibility for fund houses as market transactions become more complex and time-sensitive. However, industry experts say that the change should not be interpreted as allowing mutual funds to become leveraged investment products.

What has Sebi changed?

Under the revised framework, mutual funds can now use intraday borrowings for operational cash management requirements such as settlement of securities trades, foreign exchange transactions, mark-to-market obligations arising from derivative positions, and repayment of existing borrowings.

Sebi has also expanded the basis on which funds can borrow by allowing consideration of expected inflows that are not formally guaranteed. These may include proceeds from secondary market sales, maturity receipts, and other settlement-related cash flows. The regulator’s view is that restricting intraday borrowing solely to redemption payouts may reduce fund management flexibility and potentially affect scheme performance.

Why this should not be viewed as leverage

Aditya Agarwal, Co-founder of Wealthy.in, tells Fortune India that Sebi's decision should be understood primarily as an operational liquidity reform rather than a shift towards leveraged investing.

The revised framework enables fund houses to manage temporary redemption mismatches and settlement obligations more efficiently through short-duration borrowing during the trading day. Importantly, it does not alter the core investment profile of mutual fund schemes or permit managers to take larger investment positions.

Investor portfolios continue to remain backed by underlying assets while the additional flexibility is intended to help fund managers navigate episodic cash-flow pressures in an increasingly dynamic market environment.

As a result, the measure is expected to improve liquidity resilience and operational efficiency across the mutual fund industry without materially increasing investor risk.

What retail investors should understand

According to Agarwal, for retail investors, the most important point is that intraday borrowing does not mean mutual funds are assuming higher investment risk.

The borrowing mechanism is intended to address short-term operational liquidity requirements such as managing redemption payments and settlement obligations within the same trading day. Any borrowing remains temporary and subject to regulatory oversight. Fund managers are not being allowed to increase market exposure beyond the investment mandate of the scheme.

In practical terms, the reform seeks to make mutual fund operations more efficient and resilient during periods of market volatility or large transaction flows, while keeping the investment risk profile unchanged.

Which categories may need clearer investor communication?

Agarwal says although the relaxation applies across mutual funds, investor communication becomes especially important in categories such as debt funds, hybrid funds, international funds, ETFs, commodity-linked schemes, and funds that use derivatives.

These categories often deal with more complex settlement cycles, liquidity constraints or market-timing considerations, making temporary borrowing a useful operational tool. However, investors should understand that such borrowing is not designed to amplify returns or increase portfolio exposure.

The actual risks in these products continue to come from factors such as interest-rate movements, market volatility, currency fluctuations, commodity prices and derivative strategies—not from short-term liquidity borrowing.

Greater disclosure and investor education will therefore be important to ensure that operational borrowing is not mistaken for leverage or higher risk-taking.

What mutual fund distributors should explain

Mutual fund distributors (MFDs) are likely to play an important role in helping investors distinguish between different types of risks that are often misunderstood.

A temporary cash-flow mismatch occurs when a fund requires short-term liquidity to meet redemption or settlement obligations before expected inflows arrive. This is largely an operational issue. Portfolio liquidity risk refers to the ability of a fund to sell underlying securities without materially affecting market prices. Redemption pressure emerges when large investor withdrawals force a fund to generate cash under potentially difficult market conditions.

Market risk remains the fundamental investment risk and reflects changes in asset prices driven by economic conditions, interest rates, credit events, currency movements, and geopolitical developments. The broader objective is to strengthen liquidity management and improve investor servicing without changing the fundamental nature of mutual fund investing.