Reliance Mutual Fund. Equity Valuation Policy

Transcription

1 Equity Valuation Policy MARCH 2017

2 HISTORY SHEET Date Particulars Approved By Signature Nov 05 Incorporation of Policy Version 1.0 Sep 06 Incorporation of Policy Version 2.0 Nov 07 Incorporation of Policy Version 3.0 Dec 08 Incorporation of Policy Version 4.0 Jun 10 Incorporation of Policy Version 5.0 Dec 11 Incorporation of Policy Version 6.0 Nov12 Incorporation of Policy Version 7.0 July 13 Incorporation of Policy Version 8.0 August 13 Incorporation of Policy Version 9.0 July 14 Incorporation of Policy Version 10.0 June 15 Incorporation of Policy Version 11.0 March 16 Incorporation of Policy Version 12.0 March 17 Incorporation of Policy Version

3 TABLE OF CONTENTS 1 OBJECTIVE STRUCTURE OVERVIEW DEFINITIONS TRADED SECURITIES: NON-TRADED SECURITIES THINLY TRADED SECURITIES: UNLISTED SECURITIES THE PRINCIPAL STOCK EXCHANGE THE SECONDARY STOCK EXCHANGE ANY OTHER STOCK EXCHANGE VALUATION POLICY TRADED SECURITIES NOT TRADED ON VALUATION DATE: NON TRADED / THINLY TRADED : UNLISTED SECURITIES VALUATION POLICY FOR ADR & GDR AND ALL OVERSEAS SECURITIES WARRANTS RIGHTS FUTURES AND OPTIONS OPTIONS FUTURES VALUATION OF SUSPENDED SECURITY APPLICATION MONEY PREFERENCE SHARES CONVERTIBLE DEBENTURES CUMULATIVE CONVERTIBLE PREFERENCE SHARES (CCPS) VALUATION OF SECURITIES ON MERGER-DEMERGER VALUATION OF INDIAN DEPOSITORY RECEIPTS VALUATION OF MUTUAL FUND UNITS VALUATION OF SECURITIES LENT UNDER SECURITIES LENDING SCHEME APPENDICES APPENDIX A APPENDIX B APPENDIX C APPENDIX D APPENDIX E APPENDIX F SEBI GUIDELINES FOR IDR

4 1 Objective 1.) To adhere to SEBI guidelines and regulation on valuing equity and equity related securities. 2.) To incorporate the best market practices followed in the industry on valuations. 3.) To elaborate the process of valuing equity securities to all stakeholders involved in equity valuation. 4.) To ensure that appropriate approval matrix is formulated for valuation process flow. 2 Structure The manual consists of following sections including this one Section 1 Section 2 Section 3 Section 4 Outlines the objective, structure and overview of valuation guidelines. Definition of securities and policy terms has been given. Asset wise valuation guidelines. Provide appendices for user reference. 3 Overview The valuation policy has to be read in conjunction with the following SEBI circulars. SEBI 1996 mutual Fund regulation (eighth schedule) Appendix A MFD / CIR / No. 08 / 092 / 2000 Dated September 18, 2000 Appendix B MFD / CIR / No. 14 / 088 / 2001 Dated March 28, 2001 Appendix C MFD / CIR / No. 14 / 442 / 2002 Dated February 20, 2002 Appendix D MFD/CIR/03/526/2002 Dated May 9, 2002 Appendix E MFD/CIR/No. 9/141601/08 Dated October 18,2008 Appendix F IMD/CIR NO 2/ dated June 12, 2009 Appendix G IMD/CIR NO 16/193388/2010 dated Feb 2, 2010 H 4

5 1.) All valuations would be carried out as per the guidelines laid down in this document and as per SEBI guidelines wherever applicable. 2.) This policy would be reviewed in the event of any new guidelines issued by SEBI or any other regulatory organization. 3.) It is mandatory that the valuation policy is reviewed and approved on an annual basis by the Board of Directors. 4.) It would be the responsibility of the compliance to keep the investment team, valuation committee, boards of AMC and trustees updated about new regulatory guidelines issued pertaining to valuations. 5

6 4. Definitions 4.1 Traded Securities: A security would be considered as traded if: In the previous calender month the trading in a security is more than Rs.5 lacs OR the total volume is more than 50,000 shares across all exchanges, where the securities listed. (AND) On the valuation date security is traded on the principal / secondary stock exchange or on any other stock exchange. 4.2 Non-Traded Securities When a security (other than Government Securities) is not traded on any stock exchange for a period of thirty days prior to the valuation date, the scrip must be treated as a non traded security. 4.3 Thinly traded securities: A security would be considered as a thinly traded security If in the previous calender month the trading in a equity / equity related security is less than Rs.5 lacs and the total volume is less than 50,000 shares While the tracking of thinly traded domestic securities is done by the fund accountant, as a best practice, the Fund Management team should also track volumes of foreign securities on a monthly basis and share the results with Risk so that appropriate changes can be made in valuation methodology, if required.. 6

7 4.4 Unlisted Securities If on a valuation date a security is not listed on any of the stock exchanges, it would be considered as unlisted security The Principal Stock Exchange For the purpose of this document, principal stock exchange would be National Stock Exchange (NSE) 4.6 The Secondary Stock Exchange For the purpose of this document, secondary stock exchange would be Bombay Stock Exchange (BSE) 4.7 Any other stock exchange For the purpose of this document other exchanges would be any other exchange where the security is listed other than Principal and Secondary Stock Exchanges 7

8 5. Valuation Policy 5.1 Traded Securities 1. If on a valuation date security is traded on the principal stock exchange or on any other stock exchange the closing price of principal stock exchange is considered. 2. If on a valuation date security is not traded on the Principal stock exchange but traded on secondary stock exchange or any other exchange then closing price of the secondary exchange is considered. 3. If on a valuation date security is not traded either on the primary or secondary stock exchange the closing price of any other exchange where the security is traded would be considered. 4. For valuation of securities held by Exchange Traded Funds (ETFs) and Index funds which are benchmarked to indices relating to a particular stock exchange, the principal stock exchange will be that exchange, e.g. for a Sensex Fund, the principal stock exchange will be the BSE. 5.2 Not traded on Valuation date: In case a security is not traded on a valuation date, earliest closing price of either principal / secondary or any other stock exchange would be used, provided such date is not more than 30 days prior to the valuation date. 5.3 Non traded / Thinly Traded : Non traded/ thinly traded securities shall be valued "in good faith" by the asset management company on the basis of the valuation principles laid down below: Security constitutes Less than 5% of Net Assets & Balance sheet available within 9 months from the close of the year Valuation would be done as per the following method: I. Calculation of Net Worth per share : 8

9 [share capital + reserves (excluding revaluation reserves) -Miscellaneous expenditure & Debit balance in P&L A/C / No. of paid up shares] II. Average Capitalisation rate (P/E ratio) for the industry based upon either NSE data (if NSE data is not available then BSE data) shall be taken and discounted by 75% for the purpose of calculating P/E ratio, EPS of latest audited annual accounts will be considered. III The value as per the net worth value per share and the capital earning value calculated as above shall be averaged and further discounted by 10% for ill-liquidity so as to arrive at the fair value per share. Incase EPS as arrived in point II above is negative, EPS value for that year shall be taken as zero for arriving at capitalized earning. Security constitutes Less than 5% of Net Assets but Balance sheet is not available within 9 months from the close of the year, the Security would be Valued at zero If the security constitutes more than 5% of total assets of the scheme, an independent valuer shall be be appointed for the valuation of the said security. To determine if a security accounts for more than 5% of the total assets of the scheme, it shall be valued in accordance with the procedure mentioned above on the date of the valuation. 5.4 Unlisted Securities Security constitutes less than 5% of Net Assets & Balance sheet available within 9 months from the close of the year Valuation would be done in the following method I. Calculation of net worth per share - Lower of the figures arrived by using the formula below would be considered. Formula 1 - Net Worth per share = [share capital + free reserves- Miscellaneous expenditure/ No. of paid up shares] (OR) 9

10 Formula 2 - Net Worth per share = [share capital consideration on exercise of option/warrants received / receivable + free reserves Miscellaneous expenditure, deferred revenue expenditure, intangible assets, accumulated losses] / {Number of paid shares + Number of shares that would be obtained on conversion or exercise of outstanding warrants and options} II. Average Capitalisation rate (P/E ratio) for the industry based upon either NSE data (if NSE data is not available then BSE data) shall be taken and discounted by 75% for the purpose of calculating P/E ratio, EPS of latest audited annual accounts would be considered. III. Illiquidity Premium calculated as above shall be averaged and further discounted by 15%, so as to arrive at the fair value per share. IV. Incase EPS as arrived in point II above is negative, EPS value for that year shall be taken as zero for arriving at capitalized earning. Security constitutes Less than 5% of Net Assets but Balance sheet is not available within 9 months from the close of the year, the Security would be Valued at zero If the security constitutes more than 5% of total assets of the scheme,an independent valuer shall be be appointed for the valuation of the said security.to determine if a security accounts for more than 5% of the total assets of the scheme,it shall be valued in accordance with the procedure mentioned above on the date of the valuation. At the discretion of the AMC and with the approval of the trustees, an unlisted equity share may be valued at a price lower than the value derived using the aforesaid. 10

11 5.5 Valuation Policy For ADR & GDR and all Overseas Securities For the purpose of computation of NAV on the same day If the security/etf is listed in a time zone ahead of ours then the same days price would be used for valuation. The price in the local currency would be obtained and the closing RBI reference rate would be used to calculate the closing price in INR. If the INR price for the security is available then the same would be used for valuation. If the security/etf is listed in a time zone behind ours then the previous days price would be used for valuation. The price in local currency would be obtained and the closing RBI reference rate would be used to calculate the closing price. If the INR price for the security is available then the same would be used for valuation. If the stock/etf is listed in currency for which RBI reference rate is not available, the exchange rates available from Reuters (at 5.00 P.M IST) will be used. In case the direct exchange rates are not available on Reuters, then cross currency rate with USD would be considered and converted as per the INR/USD RBI reference rate. For the purpose of computation of NAV on the next day (T+1) The latest available closing price of the exchange on which the security is listed and RBI reference rate would be considered for valuation. If the stock is listed in a currency for which RBI reference rate is not available, the exchange rates available from Reuters (at 5.00 P.M IST) on T will be used. In case the direct exchange rates are not available on Reuters, then cross currency rate with USD would be considered and converted as per the INR/USD RBI reference rate. 5.6 Warrants If the underlying shares are thinly traded or non traded then a discount similar to the valuation of thinly traded or non traded shares would be applied to the price derived above to value the warrants. For non-traded warrants the Black Scholes option pricing model shall be used for valuation as warrants are similar to a call option. In case of the warrants been traded separately they would be valued as an equity share and valued accordingly. 5.7 Rights If the rights are traded separately then the traded price is the valuation price. If rights are not traded separately then the rights would be valued as follows. Rights would be valued as per the following formula: Vr = n* (Pex Pof), where - Vr = Value of rights - n = no. of rights offered - Pex = Ex rights price - Pof = Rights Offer price 11

12 If the rights are on non traded shares or unlisted shares then the rights would be valued at zero market price. 12

13 5.8 Futures and Options Individual stock & index, futures & options would be valued as given below Options All traded options to be valued as per the closing prices and in absence of traded closing prices at the settlement price declared by the exchange. If the settlement price is not available a theoretical price as derived by the Black &Scholes option pricing formula would be used for valuation Futures 1. On T day (valuation day), use the settlement price for valuation if the same is available by 7.00 p.m. 2. If the contract is traded and settlement price is not available by 7.00 p.m. use the closing prices for valuation and on T +1 day, take cognizance of T day s settlement price & pass necessary bank entries 3. If on T day, the contract is not traded then take latest available settlement price. On T +1 day, take cognizance of T day s settlement price & pass necessary bank entries 5.9 Valuation of Suspended Security If a listed security is suspended for a certain period, then upto 30 days the last traded price would be used for valuation and after 30 days the valuation methodology would be decided on a case to case basis and approved by the valuation committee. Securities awaiting listing due to IPO would be valued at allotment price. Likewise securities suspended due to corporate actions like merger/demerger/scheme of arrangement will be valued as per clause

14 5.10 Application Money If the allotment of securities or refund does not happen in the time period stipulated by the regulator the application money would be treated as Non Performing Asset (NPA) and would be valued as per the guidelines for valuation of NPA s stated under the Debt Valuation Policy Preference Shares Preference Shares would be valued as per the norms governing the valuation of Non Convertible debentures and Bonds as illustrated in the Debt investment policy Convertible Debentures Convertible debentures would comprise of two parts, a) convertible part which will be treated as equity share and b) Non convertible part which will be treated as bonds. The convertible part will be valued as an equity share and the valuation policy for equity shares would be applicable for it. The non convertible part will be valued a bond and the valuation will be as defined for a bond in the debt valuation policy Cumulative Convertible Preference Shares (CCPS) CCPS would be valued at the traded prices. If CCPS is not traded it would be valued along lines of convertible debentures or as valuation committee may decide. 14

15 5.14 Valuation of securities on Merger-Demerger De-merger, Merger, Amalgamation and Scheme of Arrangement Following possibilities arise which influence valuation securities due to the corporate actions: i. Both the shares are traded immediately on de-merger: In this case both the shares are valued at respective traded prices. ii. Shares of only one company continued to be traded on de-merger: Traded shares is to be valued at traded price and the other security is to be valued at traded value on the day before the de merger less value of the traded security post de merger. If in an extremely unlikely and exceptional situation if value of the share of de merged company is equal or in excess of the value of the pre de merger share, then the non traded share is to be valued at zero. The same would be reviewed by the valuation committee every 30 days if the security is not listed. iii. Both the shares are not traded on de-merger: Based on the traded price of the shares of the de-merged company prior to demerger, the value of the shares of the demerged and resulting companies will be computed. Hence, the share price of the demerged company prior to demerger will be allocated between the post-demerger companies on an appropriate basis like Price Earnings ratio, or net worth, or any other measure, as per the decision of the Valuation Committee. These values will be carried up to a period of 30 days from the date of de merger.. The same would be reviewed by the valuation committee every 30 days for the securities that are not listed. IV Merger Will be decided on case to case basis depending on the terms of merger and would have to be approved by the Valuation Committee 5.15 Valuation of Indian Depository Receipts Valuation of IDR s listed on the Indian Stock Exchange would follow the principles similar to Listed Indian Equity Shares. In case the IDR s are classified as thinly traded, the criteria as laid above for Listed Indian Equity shares shall be applied taking into consideration the relevant company s balance sheet. 15

16 5.16 Valuation of Mutual Fund Units Units listed and traded would be valued at the closing traded price as on valuation date. Unlisted units and to be listed units, or those for which no traded price is available, would be valued at the Net Asset Value(NAV) as on the valuation date 5.17 Valuation of Securities Lent under Securities Lending Scheme The valuation of securities lent under Securities Lending Scheme shall be valued as per principles as mentioned in the respective subsection of Section 5 of this policy. The lending fees received for the Securities lent out would be accrued in a proportionate manner till maturity of the contract Exceptions to this Policy In any situation that is not envisaged by this policy, or where an exception to this policy is made in the interest of fair valuation, the Valuation Committee will decide on the valuation of the securities as long as this is in line with SEBI Valuation Guidelines. 16

17 6. Appendices 6.1 Appendix A EIGHTH SCHEDULE SECURITIES AND EXCHANGE BOARD OF INDIA (MUTUAL FUNDS) REGULATIONS, 1996 [REGULATION 47] INVESTMENT VALUATION NORMS Mutual Fund shall value its investments according to the following valuation norms: NAV of a scheme as determined by dividing the net assets of the scheme by the number of outstanding units on the valuation date. 1. Traded Securities: - (i) The securities shall be valued at the last quoted closing price on the stock exchange. (ii) When the securities are traded on more than one recognized stock exchange, the securities shall be valued at the last quoted closing price on the stock exchange where the security is principally traded. It would be left to the asset management company to select the appropriate stock exchange, but the reasons for the selection should be recorded in writing. There should however be no objection for all scrips being valued at the prices quoted on the stock exchange where a majority in value of the investments is principally traded. (iii) Once a stock exchange has been selected for valuation of a particular security, reasons for change of the exchange shall be recorded in writing by the asset management company. (iv) When on a particular valuation day, a security has not been traded on the selected stock exchange; the value at which it is traded on another stock exchange may be used. (v) When a security is not traded on any stock exchange on a particular valuation day, the value at which it was traded on the selected stock exchange or any other stock exchange, as the case may be, on the earliest previous day may be used provided such date is not more than 105*[thirty] days prior to the valuation date. 2. Non-traded Securities: - (i) When a security is not traded on any stock exchange for a period of 106*[thirty] days prior to 17

18 the valuation date, the scrip must be treated as a `non-traded' scrip. (ii) Non-traded securities shall be valued "in-good faith" by the asset management company on the basis of appropriate valuation methods based on the principles approved by the Board of the asset management company. Such decision of the Board must be documented in the Board minute and the supporting data in respect of each security so valued must be preserved. The methods used to arrive at values "in-good faith" shall be periodically reviewed by the trustees and reported upon by the auditors as "fair and reasonable" in their report on the annual accounts of the fund. For the purpose of valuation of non-traded securities, the following principles should be adopted: - (a) Equity instruments shall generally be valued on the basis of capitalization of earnings solely or in combination with the net asset value, using for the purposes of capitalization, the price or earning ratios of comparable traded securities and with an appropriate discount for lower liquidity; (b) Debt instruments shall generally be valued on a yield to maturity basis, the capitalization factor being determined for comparable traded securities and with an appropriate discount for lower liquidity; 107*[(c) while investments in call money, bills purchased under rediscounting scheme and short term deposits with banks shall be valued at cost plus accrual; other money market instruments shall be valued at the yield at which they are currently traded. For this purpose, non-traded instruments that is, instruments not traded for a period of seven days will be valued at cost plus interest accrued till the beginning of the day plus the difference between the redemption value and the cost spread uniformly over the remaining maturity period of the instruments; (cc) government securities will be valued at yield to maturity based on the prevailing market rate.] (d) In respect of convertible debentures and bonds, the non-convertible and convertible components shall be valued separately. The non-convertible component should be valued on the same basis as would be applicable to a debt instrument. The convertible component should be valued on the same basis as would be applicable to an equity instrument. If, after conversion the resultant equity instrument would be traded pari passu with an existing instrument which is traded, the value of the latter instrument can be adopted after an appropriate discount for the non-tradability of the instrument during the period preceding the conversion. While valuing such instruments, the fact whether the conversion is optional should also be factored in. (e) In respect of warrants to subscribe for shares attached to instruments, the warrants can be valued at the value of the share which would be obtained on exercise of the warrant as reduced by the amount which would be payable on exercise of the warrant. A discount similar to the discount to be determined in respect of convertible debentures (as referred to in sub-paragraph (d) above) must be deducted to account for the period that must elapse before the warrant can be exercised. (f) Where instruments have been bought on `repo' basis, the instrument must be valued at the 18

19 resale price after deduction of applicable interest upto date of resale. Where an instrument has been sold on a `repo' basis, adjustment must be made for the difference between the repurchase price (after deduction of applicable interest upto date of repurchase) and the value of the instrument. If the repurchase price exceeds the value, the depreciation must be provided for and if the repurchase price is lower than the value, credit must be taken for the appreciation. 3. Until they are traded, the value of the "rights" shares should be calculated as: Vr =n x (Pex Pof) m Where Vr = Value of rights n = no. of rights offered m = no. of original shares held Pex = Ex-rights price Pof = Rights Offer Price Where the rights are not treated pari-passu with the existing shares, suitable adjustment should be made to the value of rights. Where it is decided not to subscribe for the rights but to renounce them and renunciations are being traded, the rights can be valued at the renunciation value. 4. All expenses and incomes accrued upto the valuation date shall be considered for computation of net asset value. For this purpose, while major expenses like management fees and other periodic expenses should be accrued on a day to day basis, other minor expenses and income need not be so accrued, provided the non-accrual does not affect the NAV calculations by more than 1%. 5. Any changes in securities and in the number of units be recorded in the books not later than the first valuation date following the date of transaction. If this is not possible given the frequency of the Net Asset Value disclosure, the recording may be delayed upto a period of seven days following the date of the transaction, provided that as a result of the non-recording, the Net Asset Value calculations shall not be affected by more than 108*[1%]. 109*[6. In case the Net Asset Value of a scheme differs by more than 1%, due to non - recording of the transactions, the investors or scheme/s as the case may be, shall be paid the difference in amount as follows: - (i) If the investors are allotted units at a price higher than Net Asset Value or are given a price lower than Net Asset Value at the time of sale of their units, they shall be paid the difference in amount by the scheme. (ii) If the investors are charged lower Net Asset Value at the time of purchase of their units or are given higher Net Asset Value at the time of sale of their units, asset management company shall 19

20 pay the difference in amount to the scheme. The asset management company may recover the difference from the investors.] 110*[6.Thinly traded securities as defined in the guidelines shall be valued in the manner as specified in the guidelines issued by the Board. 7. The aggregate value of illiquid securities as defined in the guidelines shall not exceed 15% of the total assets of the scheme and any illiquid securities held above 15% of the total assets shall be valued in the manner as specified in the guidelines issued by Board] Footnotes 105. Substituted for the word "sixty", by the SEBI (Mutual Funds) (Amendment) Regulations, 2001, published in the Official Gazette of India dated Substituted for the word "sixty", by the SEBI (Mutual Funds)(Amendment) Regulations, 2001, published in the Official Gazette of India dated Substituted for Clause c by the SEBI (Mutual Fund) (Amendment) Regulations, 1999, published in the Official of India Gazette dated Substituted for "2" by the SEBI (Mutual Fund) (Amendment) Regulations, 1999, published in the Official of India Gazette dated "Clause 6" inserted by the SEBI (Mutual Fund) (Amendment) Regulations, 1999, published in the Official of India Gazette dated "Clauses 6 & 7" inserted by the SEBI (Mutual Fund) (Amendment) Regulations, 1999, published in the Official of India Gazette dated

21 6.2 Appendix B DIVISION CHIEF MUTUAL FUNDS DEPARTMENT MFD/CIR/ 8 / 92 / 2000 September 18, 2000 All Mutual Funds Registered with SEBI Unit Trust of India Dear Sirs, Association of Mutual Funds in India (AMFI) made certain recommendations on valuation norms and provisioning of non-performing assets. The recommendations were placed before the Accounting Standards Committee set up by SEBI. The Committee, which also had representation from AMFI, deliberated the issues and has given its report. Enclosed herewith are (i) Guidelines for valuation of securities and (ii) Guidelines for Identification and Provisioning for NPAs. These guidelines are being issued in accordance with the provisions of Regulation 77 of SEBI (Mutual Funds) Regulations, These guidelines are supplementary to the provisions specified in SEBI regulations. A few modifications in the Regulations wherever required would be made in due course. These guidelines shall be effective from October 1, A copy of corrigendum published in the gazette notification dated July 26, 2000 is also enclosed. Yours faithfully, P. K. NAGPAL 21

22 Encl: a/a SECURITIES AND EXCHANGE BOARD OF INDIA MUTUAL FUNDS DEPARTMENT GUIDELINES FOR VALUATION OF SECURITIES FOR MUTUAL FUNDS Mutual funds shall categorize the securities according to the following norms: 1. Traded Securities : When a security (other than Government Securities) is not traded on any stock exchange on a particular valuation day, the value at which it was traded on the selected stock exchange or any other stock exchange, as the case may be, on the earliest previous day may be used provided such date is not more than thirty days prior to valuation date. 2. Thinly Traded Securities : (i) Thinly Traded Equity/Equity Related Securities : When trading in an equity/equity related security (such as convertible debentures, equity warrants, etc.) in a month is less than Rs. 5 lacs or the total volume is less than 50,000 shares, it shall be considered as a thinly traded security and valued accordingly. Where a stock exchange identifies the "thinly traded" securities by applying the above parameters for the preceding calendar month and publishes/provides the required information along with the daily quotations, the same can be used by the mutual funds. If the share is not listed on the stock exchanges which provide such information, then it will be obligatory on the part of the mutual fund to make its own analysis in line with the above criteria to check whether such securities are thinly traded which would then be valued accordingly. 22

23 In case trading in an equity security is suspended upto 30 days, then the last traded price would be considered for valuation of that security. If an equity security is suspended for more than 30 days, then the Asset Management Company/Trustees will decide the valuation norms to be followed and such norms would be documented and recorded. (ii) Thinly Traded Debt Securities: A debt security (other than Government Securities) that has a trading volume of less than Rs. 5 crores in the previous calendar month shall be considered as a thinly traded security based upon information provided by the relevant stock exchange on the volume of debt securities traded. A thinly traded debt security as defined above would be valued as per the norms set for non-traded debt security. 3. Non-Traded Securities: When a security (other than Government Securities) is not traded on any stock exchange for a period of thirty days prior to the valuation date (instead of the existing provision of 60 days), the scrip must be treated as a non traded security. VALUATION OF NON-TRADED / THINLY TRADED SECURITIES Non traded/ thinly traded securities shall be valued "in good faith" by the asset management company on the basis of the valuation principles laid down below: (i) Non-traded / thinly traded equity securities: (a) Based on the latest available Balance Sheet, net worth shall be calculated as follows: (b) Net Worth per share = [share capital+ reserves (excluding revaluation reserves) Misc. expenditure and Debit Balance in P&L A/c] Divided by No. of Paid up Shares. 23

24 (c) Average capitalisation rate (P/E ratio) for the industry based upon either BSE or NSE data (which should be followed consistently and changes, if any noted with proper justification thereof) shall be taken and discounted by 75% i.e. only 25% of the Industry average P/E shall be taken as capitalisation rate (P/E ratio). Earnings per share of the latest audited annual accounts will be considered for this purpose. (d) The value as per the net worth value per share and the capital earning value calculated as above shall be averaged and further discounted by 10% for ill-liquidity so as to arrive at the fair value per share. (e) In case the EPS is negative, EPS value for that year shall be taken as zero for arriving at capitalized earning. (f) In case where the latest balance sheet of the company is not available within nine months from the close of the year, unless the accounting year is changed, the shares of such companies shall be valued at zero. (g) In case an individual security accounts for more than 5% of the total assets of the scheme, an independent valuer shall be appointed for the valuation of the said security. (ii)(a) Non Traded /Thinly Traded Debt Securities of Upto 182 Days to Maturity : As the money market securities are valued on the basis of amortization (cost plus accrued interest till the beginning of the day plus the difference between the redemption value and the cost spread uniformly over the remaining maturity period of the instruments) the same process should be adopted for non-traded debt securities with residual maturity of upto 182 days, in the absence of any other standard benchmarks in the market. All other non traded Non Government debt instruments should be valued using the method suggested in (ii)(b) hereof. 24

25 (ii)(b) Non Traded/ Thinly Traded Debt Securities of Over 182 Days to Maturity. For the purpose of valuation, all Non Traded Debt Securities would be classified into "Investment grade" and "Non Investment grade" securities based on their credit ratings. The non-investment grade securities would further be classified as "Performing" and "Non Performing" assets o o o All Non Government investment grade debt securities, classified as not traded, shall be valued on yield to maturity basis as described below. All Non Government non investment grade performing debt securities would be valued at a discount of 25% to the face value All Non Government non-investment grade non-performing debt securities would be valued based on the provisioning norms. The approach in valuation of non-traded debt securities is based on the concept of using spreads over the benchmark rate to arrive at the yields for pricing the non-traded security. The Yields for pricing the non-traded debt security would be arrived at using the process as defined below. Step A A Risk Free Benchmark Yield is built using the government securities (GOI Sec) as the base. GOI Secs are used as the benchmarks as they are traded regularly; free of credit risk; and traded across different maturity spectrums every week. 25

26 Step B A Matrix of spreads (based on the credit risk) are built for marking up the benchmark yields. The matrix is built based on traded corporate paper on the wholesale debt segment of an appropriate stock exchange and the primary market issuances. The matrix is restricted only to investment grade corporate paper. Step C The yields as calculated above are Marked-up/Marked-down for ill-liquidity risk. Step D The Yields so arrived are used to price the portfolio. METHODOLOGY A. Construction of Risk Free Benchmark Using Government of India dated securities, the Benchmark shall be constructed as below : Government of India Dated securities will be grouped into the following duration buckets viz., years, 1-2 years, 2-3 years, 3-4 years, 4-5 years, 5-6 years and 6 years and the volume weighted yield would be computed for each bucket. Accordingly, there will be a benchmark YTM for each duration bucket. The benchmark as calculated above will be set weekly, and in the event of any change in the Reserve Bank of India (RBI) policies affecting interest rates during the week, the benchmark will be reset to reflect any change in the market conditions. Note : The concept of duration over tenor has been chosen in order to capture the reinvestment risk. It is intended to gradually move towards a methodology that incorporates the continuous curve approach for valuation of such securities. However, in view of the current lack of liquidity in the corporate bond markets, a continuous curve approach to valuation would be necessarily based on limited data points, and this would result in out of line valuations. As an interim methodology therefore it is proposed that the 26

27 Duration Bucket approach be adopted and continuously tracked in order to fine tune the duration buckets on a periodic basis. Over the next few years it is expected that with the deepening of the secondary market trading, it would be possible to make a gradual move from the Duration Bucket approach towards a continuous curve approach. B. Building a Matrix of Spreads for Marking-up the Benchmark Yield Mark up for credit risk over the risk free benchmark YTM as calculated in step A, will be determined using the trades of corporate debentures/bonds of different ratings. All trades on appropriate stock exchange during the fortnight prior to the benchmark date will be used in building the corporate YTM and spread matrices. Initially these matrices will be built only for corporate securities of investment grade. The matrices are dynamic and the spreads will be computed every week. The matrix will be built for all duration buckets for which the benchmark GOI matrix is built to effectively link the corporate matrix with the GOI securities matrix. Accordingly: o o o o o o All traded paper (with minimum traded value of Rs. 1 crore) will be classified by their ratings and grouped into 7 duration buckets; for rated securities, the most conservative publicly available rating will be used; For each rating category, average volume weighted yield will be obtained both from trades on the appropriate stock exchange and from the primary market issuances Where there are no secondary trades on the appropriate stock exchange in a particular rating category and no primary market issuances during the fortnight under consideration, then trades on appropriate stock exchange during the 30 day period prior to the benchmark date will be considered for computing the average YTM for such rating category; If the matrix cannot be populated using any or all of the above steps, then credit spreads from trades on appropriate stock exchange of the relevant rating category over the AAA trades will be used to populate the matrix; In each rating category, all outliers will be removed for smoothening the YTM matrix; Spreads will be obtained by deducting the YTM in each duration category from the respective YTM of the GOI securities; 27

28 In the event of lack of trades in the secondary market and the primary market the gaps in the matrix would be filled by extrapolation. If the spreads cannot be extrapolated for the reason of practicality, the gaps in the matrix will be filled by carrying the spreads from the last matrix. C. Mark-up/Mark-down Yield The Yields calculated would be marked-up/marked down to account for the ill-liquidity risk, promoter background, finance company risk and the issuer class risk. As the level of illliquidity risk would be higher for non-rated securities the marking process for rated and nonrated securities would be differentiated as follows C (I) Adjustments for Securities rated by external rating agencies The Yields so derived out of the above methodology could be adjusted to account for risk mentioned above. A Discretionary discount/premium of upto +/-50 Basis Points for securities having a duration of upto 2 years and upto +/- 25 Basis Points for securities having duration higher than 2 years will be permitted to be provided for the above mentioned types of risks. The rationale for the above discount structure is to take cognizance of the differential interest rate risk of the securities. This structure will be reviewed periodically. C (II) Adjustments for Internally Rated Securities To value an un-rated security, the fund manager has to assign an internal credit rating, which will be used for valuation. Since un-rated instruments tend to be more illiquid than rated securities, the yields would be marked up by adding +50 basis point for securities having duration of upto two years and +25 basis point for securities having duration of higher than two years to account for the illiquidity risk. 28

29 Valuation of securities with Put/Call Options The option embedded securities would be valued as follows: Securities with call option: The securities with call option shall be valued at the lower of the value as obtained by valuing the security to final maturity and valuing the security to call option. In case there are multiple call options, the lowest value obtained by valuing to the various call dates and valuing to the maturity date is to be taken as the value of the instrument. Securities with Put option The securities with put option shall be valued at the higher of the value as obtained by valuing the security to final maturity and valuing the security to put option In case there are multiple put options, the highest value obtained by valuing to the various put dates and valuing to the maturity date is to be taken as the value of the instruments. Securities with both Put and Call option on the same day The securities with both Put and Call option on the same day would be deemed to mature on the Put/Call day and would be valued accordingly. (ii)(c) Government securities (not traded for more than 30 days or one which would qualify as a thinly traded security) will be valued at cost plus accrual and amortizing the discount or premium over the like of the security. Illiquid Securities: (a) Aggregate value of "illiquid securities" of scheme, which are defined as non-traded, thinly traded and unlisted equity shares, shall not exceed 15% of the total assets of the scheme and any illiquid securities held above 15% of the total assets shall be assigned zero value. Provided that in case any scheme has illiquid securities in excess of 15% of total assets as on September 30, 2000 then such a scheme shall within a period of two years bring down the ratio of illiquid securities within the prescribed limit of 15% in the following time frame: (i) All the illiquid securities above 20% of total assets of the scheme shall be assigned zero value on September 30, (ii) All the illiquid securities above 15% of total assets of the scheme shall be assigned zero value on September 30,

30 (b) All funds shall disclose as on March 31 and September 30 the scheme-wise total illiquid securities in value and percentage of the net assets while making disclosures of half yearly portfolios to the unit holders. In the list of investments, an asterisk mark shall also be given against all such investments which are recognized as illiquid securities. (c) Mutual Funds shall not be allowed to transfer illiquid securities among their schemes w.e.f. October 1, (d) In respect of closed ended funds, for the purposes of valuation of illiquid securities, the limits of 15% and 20% applicable to open-ended funds should be increased to 20% and 25% respectively. (e) Where a scheme has illiquid securities as at September 30, 2001 not exceeding 15% in the case of an open-ended fund and 20% in the case of closed fund, the concessions of giving time period for reducing the illiquid security to the prescribed limits would not be applicable and at all time the excess over 15% or 20% shall be assigned nil value. 30

31 6.3 Appendix C MFD/CIR/14 /088 / 2001 March 28, 2001 All Mutual Funds Registered with SEBI/ Unit Trust of India Dear Sirs, As you are aware, SEBI issued guidelines for the valuation of securities and identification and provisioning for non-performing assets (debt securities) vide circular no MFD/CIR/8/92/2000 dated September 18, Association of Mutual Funds in India (AMFI) has made a representation for certain modification in the guidelines. After examining the matter, the following modifications have been made in the guidelines issued vide aforesaid circular: Guidelines For Valuation of Securities a) Thinly Traded Equity / Equity Related Securities The definition for Thinly Traded Equity / Equity Related Securities given in Section 2(i) of the Guidelines (Pg. 1) shall be replaced by the following definition: "When trading in an equity/equity related security (such as convertible debentures, equity warrants, etc.) in a month is both less than Rs. 5 lacs and the total volume is less than 50,000 shares, it shall be considered as a thinly traded security and valued accordingly". For example, if the volume of trade is 100,000 and value is Rs. 400,000, the share does not qualify as thinly traded. Also if the volume traded is 40,000, but the value of trades is Rs. 600,000, the share does not qualify as thinly traded. Further it is clarified that in order to determine whether a security is thinly traded or not, the volumes traded in all recognized stock exchanges in India may be taken into account. 31

32 b) Thinly Traded Debt Security The definition for Thinly Traded Debt Security given in first paragraph of Section 2(ii) of the Guidelines (Pg. 1) shall be replaced by the following definition: "A debt security (other than Government Securities) that has a trading volume of less than Rs. 15 crores for a period of thirty days prior to the valuation date shall be considered as a thinly traded security based upon information provided by the stock exchanges on the volume of trading of debt securities". In order to determine whether a security is thinly traded or not the volumes traded in all recognized stock exchanges in India may be taken into account. c) Non-Traded / Thinly Traded Equity/ Equity Related Securities For the sake of clarification, in sub-clause (g) of clause (i) of the Guidelines (Pg. 2), the following sentence is now added, " To determine if a security accounts for more than 5% of the total assets of the scheme, it should be valued by the procedure above and the proportion which it bears to the total net assets of the scheme to which it belongs would be compared on the date of valuation". d) Non Traded / Thinly Traded Debt Securities of upto 182 days to maturity The valuation model given in clause (ii)(a) of the Guidelines (Pg. 2) shall be substituted by the following: "As the money market securities are valued on the basis of amortization (cost plus accrued interest till the beginning of the day plus the difference between the redemption value and the cost spread uniformly over the remaining maturity period of the instruments) a similar process should be adopted for non-traded debt securities with residual maturity of upto 182 days, in the absence of any other standard benchmarks in the market. Debt securities purchased with residual maturity of upto 182 days are to be valued at cost (including accrued interest till the beginning of the day) plus the difference between the redemption value (inclusive of interest) and cost spread uniformly over the remaining maturity period of the instrument. In case of a debt security with maturity greater than 182 days at the time of purchase, the last valuation price plus accrued interest should be used 32

33 instead of purchase cost. All other non traded Non Government debt instruments shall be valued using the method suggested in (ii)(b) hereof". e) Government Securities The valuation method given in clause (ii)(c) of the Guidelines (Pg. 6) pertaining to valuation of government securities not traded for more than 30 days or one which would qualify as a thinly traded security is now deleted. Such securities shall be valued at yield to maturity based on the prevailing market rate, in accordance with item (cc) of Clause 2 of the Eighth Schedule of SEBI (Mutual Funds) Regulations, Guidelines For Identification and Provisioning For Non Performing Assets (Debt Securities) For Mutual Funds Reclassification of assets In sub-clause (4)of clause (E) of the Guidelines (Pg. 3), it is clarified that the words "2 nd quarter" wherever appear, shall mean 2 nd calendar quarter. These guidelines effective immediately are being issued in accordance with the provisions of Regulation 77 of SEBI (Mutual Funds) Regulations, Yours faithfully, P. K. NAGPAL GENERAL MANAGER MUTUAL FUNDS DEPARTMENT 33

34 6.4 Appendix D CHIEF GENERAL MANAGER MUTUAL FUNDS DEPARTMENT MFD/CIR February 20, 2002 All Mutual Funds Registered with SEBI Unit Trust of India Association of Mutual Funds in India No.14/442/2002 Dear Sirs, As you are aware, SEBI issued guidelines for valuation of securities vide circulars dated September 18, 2000 and March 28, Association of Mutual Funds in India (AMFI) has made a representation for certain modifications in the guidelines. After examining the matter, the following modifications have been made in the guidelines: 1. Traded Securities The definition for traded securities given on page 1 of the circular dated September 28, 2000 shall be replaced by the following definition: When a security (other than debt securities) is not traded on any stock exchange on a particular valuation day, the value at which it was traded on the selected stock exchange, as the case may be, on the earliest previous day may be used provided such date is not more than thirty days prior to valuation date. When a debt security (other than Government Securities) is not traded on any stock exchange on any particular valuation day, the value at which it was traded on the principal stock exchange or any other stock exchange, as the case may be, on the earliest previous day may be used provided such date is not more than fifteen days prior to valuation date. When a debt security (other than Government Securities) is purchased by way of private placement, the value at which it was bought may be used for a period of fifteen days beginning from the date of purchase. 34

35 2. Thinly Traded Debt Security The definition of a thinly traded debt security given in pt. 2 (page 2) of circular dated March 28, 2001 shall be replaced by the following definition: A debt security (other than Government Securities) shall be considered as a thinly traded security if on the valuation date, there are no individual trades in that security in marketable lots (currently Rs 5 crore) on the principal stock exchange or any other stock exchange. 3. Construction of Risk Free Benchmark The paragraph on Construction of Risk Free Benchmark given on page 4 of the circular dated September 18, 2000 for valuation of securities shall be replaced by the following paragraph : GOI dated securities will be grouped into various duration buckets such as years, 1-2 years, 2-3 years,3-4 years, 4-5 years, 5-6 years and 6 years and the volume weighted yield would be computed for each bucket. These duration buckets may be changed to reflect the market value more closely by any agency suggested by AMFI giving benchmark yield/matrix of spreads over benchmark yield. The benchmark as calculated above will be set at least weekly, and in the event of any significant movement in prices of Government Securities on account of any event impacting interest rates on any day such as a change in the Reserve Bank of India (RBI) policies, the benchmark will be reset to reflect any change in the market conditions. 35