Industry body Amfi on Friday said it fully supports the capital markets regulator Sebi's new rule, which puts a cap on mutual fund exposure to perpetual bonds.
The industry body recognises that the risk profile of such instruments is higher than regular bonds.
The Securities and Exchange Board of India (Sebi) came out with a circular on review of norms regarding investment in debt instruments with special features and the valuation of perpetual bonds on Wednesday.
Under the new rule, mutual funds cannot invest more than 10 per cent of the scheme's corpus in debt instruments, with special features such as perpetual bonds, and the exposure cannot not be more than 5 per cent to such debt instruments of the same company.
In addition, maturity of all perpetual bonds needs to be treated as 100 years from the date of issuance of the bond for the "purpose of valuation".
In a statement, the Association of Mutual Funds in India (Amfi) said it "fully supports the need and spirit of the circular in capping exposure to perpetual bonds".
It further said most of the mutual fund schemes are well below the cap specified in the circular.
In few of the schemes where perpetual bond exposure is higher than the Sebi prescribed cap, grand fathering is permitted by the regulator to ensure that there is no unnecessary market disruption, the industry body noted.
The industry body said Sebi had engaged with Amfi on treatment of perpetual bonds as it is a hybrid instrument and carries a differentiated risk reward ratio than a normal debt instrument.
Treatment of perpetual bonds was discussed in the Mutual Fund Advisory Committee (MFAC) where several members of Amfi participated.
Perpetual bonds or Additional Tier-I Bonds are issued without any maturity date but are usually issued with call options and qualify for Tier-I capital. Banks have been majority issuers of perpetual bonds.
The perpetual bond market is reasonably active with regular trades in large and higher rated issuances. Most trades in perpetual bonds happen on a yield to call basis. This is based on the established market convention, locally as well as globally, that the issuer will exercise the call option on the due date.
Amfi said it also supports Sebi's objective of fair valuation as market determined price is the best price to arrive at a valuation which is fair to investors who are subscribing, redeeming or staying invested in a mutual fund scheme.
The industry body under guidance from Sebi has worked over the years to create a robust valuation process and two independent agencies administer the process to ensure industry wide fair and common valuation for the debt portfolio across mutual funds.
The new circular continues the tradition of the primacy of traded prices, Amfi noted.
Perpetual bond market sees active participation from various players -- banks, corporates, mutual funds and individual investors.
"Only in the event of lack of traded prices, the question arises as to whether the bond should be valued to call or to maturity. Given a reasonably active market with regular trades, the issue is narrower than it appears," it added.
Amfi said it is in discussion with Sebi to further smoothen the process of implementation of this circular.
The regulator has always been concerned about any potential mispricing of risk in any kind of instruments.
Recognising that mispricing of risk is not in the best interest of its investors, Amfi said it committed to working with Sebi to ensure fair valuation of its investments.
It is also fully committed to the regulator's objectives of investor protection and development of markets in India with the highest level of transparency.
While in the short-term prices can be influenced by many factors, in the long-term fundamentals will prevail, the industry body said.