With the recently inaugurated Corporate Debt Market Development Fund, the market regulator hopes to "prevent another Franklin Templeton fiasco," wrote Anshul Gupta, the co-founder, and CIO of WintWealth.
In April 2020, Franklin Templeton wound up six of its debt schemes because of high redemption pressure following the pandemic mayhem, and the schemes were invested in illiquid securities.
Also read: Finance Minister inaugurates bail-out Facility for debt funds
In a long thread, Gupta explained in detail the difficulties faced by debt-fund managers and how the new development fund could help.
“This is a great and unique solution to manage the structural liquidity problem until our (debt) markets mature,” wrote Gupta, whose WintWealth recently got an online bond platform provider licence.
He wrote that those familiar with the debt market would know how illiquid the securities are. When there is stress on the market, the situation worsens and “liquidity disappears”. On the other hand, investors panic and look to sell their mutual-fund holdings.
Gupta wrote that this is where the problem lies. “The debt funds are liquid and can be easily sold by investors. But the securities that these mutual funds invest in are not that liquid. It is difficult to sell this underlying debt and meet the redemptions,” he wrote.
This is what happened with Franklin Templeton funds; there was an asset-liability mismatch, he explained.
Sebi’s plan is to set up a super fund that will buy these underlying, illiquid securities when there is an event that dislocates the market, like the pandemic.
But who will fund this super fund?
A few of the debt mutual funds will do that. They will contribute 25 bps of their AUM to this fund, and their contributions will increase in proportion to their AUM.
All AMCs will need to make a one-time contribution of 2 bps of their debt AUM to the fund, wrote Gupta.
These funds should not mind contributing to the superfund because they stand to benefit from it, also they will be earning returns from the fund’s investments in GSecs, T-Bills and so on.
Gupta wrote that currently, going by mutual-fund statistics, the fund would raise Rs 3,000 crore. That won’t be enough but the superfund has the option to borrow up to 10x the amount they hold from Member-lending institutions (MLIs) like banks when the need arises.
To reassure banks, the National Credit Guarantee Trustee Company will guarantee their borrowing up to Rs 30,000 crore. For this, the MLIs will pay 0.5 percent to the Guarantee Fund.
Whatever money the mutual funds need at the time of a crisis, 90 percent of that will be covered in cash and 10 percent will be covered in units of the super fund.
Gupta explained that there is also a mechanism to encourage debt schemes to invest in good quality stocks, besides allowing only coverage for investment-grade securities (BBB- and above).
If there is a default by the bond issuers, then losses will be absorbed first by the units given to the mutual funds against the purchase of bonds. Then losses will flow to the contribution of debt schemes and AMCs wrote Gupta. After that, the government guarantee is invoked to pay the MLIs.
“This means that losses are first borne by the schemes which sold the bonds to the CDMDF and last by MLIs. This removes the moral hazard for debt schemes to invest in poor quality bonds and then sell them to CDMDF.”
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