The Securities and Exchange Board of India (SEBI) on Monday lowered the amount of corporate debt that mutual funds can hold in individual companies and sectors to prevent investors from potentially damaging over-exposure.
The rules are in response to market turmoil last year when a unit of JP Morgan in India suffered significant mark-to-market losses after a big investment in the debt by Amtek Auto Ltd soured when the auto parts maker was downgraded by rating agencies.
The new rules, announced after a board meeting on Monday, were widely expected given India's market regulator had previously said it would closely review potential risks in the corporate debt investments by mutual funds.
The SEBI is not only cutting how much company debt a single fund can hold, it is also imposing restrictions on investments in related entities as well as sectors.
The rules will also force companies to diversify their investor base, bankers said.
"Mutual funds will have to diversify the companies in which they will invest now that there is a single and group borrower limit," said a debt investment banker at a foreign bank.
"Also companies will have to find other avenues to raise funds like from banks, insurance companies."
The rules require funds to not hold more than 10 per cent of its net assets in debt issued by a single company—down from 15 per cent earlier.
That limit would be extendable to 12 per cent after approval from the fund's trustee compared with 20 per cent earlier—the amount of debt a J.P.Morgan fund had held in Amtek Auto's debt.
The SEBI rules also bar a fund from holding more than 20 per cent of its net asset value in companies belonging to the same corporate group, though it is extendable to 25 per cent after approval from the trustee.
The regulator also reduced the amount of exposure debt funds can hold on a single sector from 30 per cent to 25 per cent of net assets, among other restrictions.
SEBI said the restrictions do not apply to debt issued by state-run companies and banks.
However, some fund managers warned they could now be forced to buy debt from more companies, potentially pushing them towards riskier bonds they would not have previously considered.
"People will now buy more riskier paper to meet the criteria, so instead of diversifying risk they have increased the risk in the system," said Murthy Nagarajan, head of fixed income at Quantum Asset Management.
Separately, SEBI also approved rules for the issuance of green bonds and primary issuance of debt through an electronic platform, finalising the draft rules announced in November.