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The liquidity crisis has finally lead to an overhaul of rules regulating closed-end funds

The Securities and Exchange Board of India in its board meeting today decided to fix the structural flaw in fixed maturity plans.

It was decided that no early exit will be allowed in any scheme of mutual fund in the nature of a closed-end scheme.  The schemes which have been approved earlier but not yet launched will also have to be amended accordingly.  It will be obligatory for the asset management company to list the close ended schemes. The board also decided that for such close ended schemes the underlying assets will not have a maturity beyond the date on which the scheme expires.

This regulatory obligation will save fund managers from distress sale if investors decide to redeem their money before maturity. This is with an intent to guard the interest of the remaining investors. The order will also drive fund managers to be disciplined in building their portfolio as fund have been debarred from buying bonds of longer maturity than their own.

For investors, the order will mean a compromise on the interim liquidity and NAV realisation as closed-end listed funds generally trade at steep discount to their NAV.  In any case, FMPs’ ownership profile makes them unsuitable for listing. There are a very large number of FMPs which serve a fairly limited pool of investors. Under the circumstances, the existence of a liquid market for any individual FMP is unlikely.

For all practical purposes, this order strips FMPs of their feature of premature encashment. Investors will now have to approach FMPs as investments that have a genuine lock-in.

However, this fix applies only to all new funds to be launched. This will not save existing fixed maturity plans from the problem caused by premature redemptions.