Easier Operational Cash Flow

Sebi is proposing to allow mutual funds to borrow money for longer periods within the trading day. This change comes from requests by the Association of Mutual Funds in India (AMFI), which highlighted ongoing operational issues. Fund managers often face delays between making payments and receiving funds, which disrupts trading and management. The new rules would let mutual funds use these short-term loans for trade settlements, foreign exchange needs, and derivative margin payments, not just investor redemptions. This recognizes that in today's markets, different settlement times can create temporary cash shortages. Earlier rules, set to take effect April 1, 2026, limited these loans mainly to guaranteed payments and redemptions. The industry pushed back, citing operational difficulties, and the rules were postponed to July 15, 2026.

Managing Leverage Risks

While this offers more flexibility, it also brings a greater risk of short-term borrowing, or leverage, for mutual funds. Sebi insists that all intraday loans must be fully repaid by the end of each trading day. Any borrowing that carries over to the next day is capped at 20% of a fund's net asset value and can only last six months. Asset Management Companies (AMCs) are fully responsible for these short-term debts, including any costs or losses. The mutual fund schemes themselves are not liable. The earlier, stricter rules were postponed because AMCs weren't fully ready. This shows the need for AMCs to have strong internal controls and careful oversight when using this new flexibility.

Regulatory Background

This proposal updates Sebi's rules on managing fund liquidity, based on the Sebi (Mutual Funds) Regulations, 2026. These regulations allow funds to borrow up to 20% of their net assets for up to six months for redemptions, interest, and specific trade settlements for index funds and ETFs. A March 13, 2026 circular introduced tighter rules, allowing intraday borrowing only for guaranteed payments and specific payouts. But AMFI argued these limits restricted fund managers and their ability to trade on the same day. This led to the current, broader proposal that eases these restrictions and expands what loans can be used for. The public can comment on this proposal until June 3, 2026, with a final framework expected later this year.

Economy and Interest Rate Impact

This regulatory change comes as the economy and interest rates are changing. While the rules focus on day-to-day cash flow, interest rate changes can affect how well funds perform. Higher interest rates make it more expensive for companies to borrow, potentially hurting profits and equity fund returns. Lower rates often help businesses grow and can boost stock markets. For bond funds, rising rates usually lower bond prices and fund values. Funds holding longer-term bonds are more affected. In this climate, the proposed increase in intraday cash flexibility could help fund managers deal with market ups and downs and manage their money better when interest rates are changing. Managing short-term cash flow becomes more important when economic policy changes can quickly affect market mood.

Concerns Over Leverage Risk

While the plan to expand intraday borrowing aims to smooth operations, it also quietly adds a significant risk of higher short-term leverage for Indian mutual funds. The main worry is whether Asset Management Companies (AMCs) will strictly follow Sebi's rule to repay loans by the end of the day. The fact that similar rules were postponed to July 15, 2026, because AMCs weren't fully ready, suggests the industry isn't equally prepared to handle this greater flexibility. This raises concerns about AMCs potentially mismanaging cash or using these loans too much to hide funding gaps, especially when compared to more developed markets with tighter short-term leverage rules. Although rules state AMCs must cover all costs, mistakes or unexpected market events could still strain funds if these borrowing tools are used too much without strong risk management. It's up to AMCs to make sure these tools improve efficiency and don't lead to too much unmanaged short-term debt.