Mutual Fund News : Indian Mutual Funds May Soon Be Permitted to Invest in Overseas Funds

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The capital market regulator, SEBI, vide a consultation paper dated May 17, 2024, has signified its intention of allowing Indian mutual funds to invest in overseas funds, provided that the total exposure to Indian securities by such overseas mutual funds is not more than 20% of their net assets

At present, Indian mutual funds are not explicitly permitted to invest in overseas mutual fund units that have exposure to Indian securities. Thus, many mutual funds in the industry steer clear from doing so.

As per the regulatory guidelines, the following are the eligible securities currently allowed for making overseas investments:

  • ADRs/GDRs issued by Indian or foreign companies

  • Equities of overseas companies listed on the stock exchanges overseas

  • Derivatives traded on the recognised stock exchange overseas only for hedging and portfolio balancing with underlying securities

  • Foreign debt securities in the countries with fully convertible currencies, short-term as well as long-term debt  instruments  with ratings not  below  investment grade by accredited/ registered credit rating agencies

  • Investment in government securities where the countries are not rated below the investment grade

  • Money market instruments rated not below investment grade

  • Repos in the form of investment, where the counterparty is rated not below the investment grade. The repos should not, however, involve any borrowing of funds by mutual fund

  • Short-term deposits with banks overseas where the issuer is rate not below the investment grade

  • Units/securities issued by overseas Mutual Funds or Unit Trusts (MF/UTs) registered with overseas regulators

The RBI, however, has set limitations on the total amount of money mutual funds can invest outside India. This overall limit currently stands at USD 7 billion.

Why is the regulator now proposing investments in overseas mutual funds?

Well, the rationale of the regulator, who is doing this in consultation with industry stakeholders and the Mutual Fund Advisory Committee (MFAC) is that the exposure of the MSCI Emerging Market Index  (MEMI)  to  Indian  Securities has shown a steady increase over the years.

Given the country's robust economic prospects, there can be a further increase in allocation toward Indian Securities by overseas funds/indices. Hence, to strike a balance between facilitating investments in overseas funds with exposure to India and preventing excessive exposure, a limit of  20%  is deemed appropriate.

What if the overseas mutual funds do not follow the aforesaid limit?

If the exposure to Indian securities by overseas mutual funds is above 20% at the time of investing (both fresh and subsequent),  it shall be considered non-compliance.

Subsequent to the investment if the exposure exceeds 20% of the net assets, an observance period of 6 months from the date of publicly available information of such breach (e.g. portfolio disclosures) shall be permitted to Indian Mutual Fund schemes for monitoring of any portfolio rebalancing activity by the underlying overseas mutual fund.

So, technically speaking, during the observance period, the Indian mutual fund scheme will not be permitted to make fresh investments into the overseas mutual fund. Only when the exposure is brought down below the limit of 20%, the new investment in overseas mutual funds may resume.  

Now, in case the portfolio of an underlying overseas mutual fund is not rebalanced within the 6-month observance period, the Indian mutual fund scheme would have to liquidate its investments in concerned underlying overseas mutual funds within the next 6 months (‘liquidation period’) from the end of the observance period.

Failure to rebalance the portfolio in such a case will be considered non-compliance and the Indian mutual fund/Asset Management Company (AMC) shall not be allowed to accept fresh subscriptions in the concerned Indian mutual fund scheme, will not be able to launch any new scheme, and will not be able to levy exit load, if any, on the investors exiting such a scheme(s).

At present, this consultation paper from Sebi is available for public comments which can be made before June 7, 2024.  Comments can be offered on whether the 20% limit is appropriate, whether passive schemes viz. ETFs and Index Funds should be excluded from the 20% exposure limit, and whether the proposal regarding the breach is appropriate.

Your comments may be submitted through the following link: https://www.sebi.gov.in/sebiweb/publiccommentv2/PublicCommentAction.do?doPublicComments=yes