Kayezad E. Adajania Moneycontrol news
After weeks of deliberation, the Securities and Exchange Board of India (SEBI) allowed mutual funds to segregate their holdings in stressed securities. Known as side-pocketing in mutual fund (MF) parlance, this refers to a practice where fund houses isolate risky assets from the rest of their holdings and cap redemption.
Once segregated, a set of units will contain investments made in the troubled paper, while the other set of units will contain all other investments and cash holdings.
This will ensure that if a paper gets downgraded to 'default' grade and the fund doesn't receive the money from its underlying investment in time, resulting in a sharp drop in the scheme's net asset value (NAV), the bad asset will then be segregated.
Subsequent to the split, the segregated portion with the bad investment gets closed for subscriptions as well as redemptions. The 'good' portion of the scheme will be open for subscription and redemption as usual. If and when the fund house recovers the money from the bad assets, it pays off the money to unit holders whose investments were stuck in the fund before the default.
Previously, SEBI was not in favour of allowing funds to side-pocket or segregate their bad units. In 2016 -- post the JP Morgan Asset Management (India)'s investments in Amtek Auto defaulting and the fund house resorting to side-pocketing at the time -- the Association of Mutual Funds of India (Amfi) had approached Sebi to set rules for creation of side-pockets when faced with a credit event.
At the time, SEBI rejected the request. In a board meet held on December 12, in Mumbai, SEBI accepted the recommendations to allow side-pocketing made the SEBI's mutual fund advisory committee.
Earlier this year, debt fund investors in many schemes saw a sharp fall in their NAVs after these schemes' investments in Infrastructure Leasing & Financial Services Ltd (IL&FS) and some of its subsidiaries saw credit rating downgrades.
The question is: Will this encourage mutual funds to take more credit risk because they now know there is a mechanism to segregate bad apples in the portfolio should a crisis emerge? "No. Enough steps will be taken and safeguards will be put in by Sebi to ensure that this facility is not misused. The final guidelines will contain these safeguards," said SEBI Chairman Ajay Tyagi.
Sandeep Parekh, founder of Finsec Law Advisors, a financial sector law firm based in Mumbai said, “I don’t think it will result in increased amount of credit risks because there is a large reputational problem of being associated with holding defaulted paper. At the same time, problems could infect an entire sector, like the present NBFC contagion. It would be unfair to block multiple side pockets, and would run contrary to one of the purposes of enabling side pockets. That of protecting a run on the system itself."
In a first in the Indian mutual funds industry, JP Morgan Asset Management (India) Pvt Ltd had resorted to this practice in September 2015, when two of its schemes' underlying investment in Amtek Auto saw a sharp fall in their NAVs when Amtek Auto's credit rating fell sharply. As per the fund's August-end portfolio on its website back then, JP Morgan India Short Term Income Fund and JP Morgan India Treasury Fund had held 10.78 percent and 5.87 percent of their corpus, respectively, in Amtek Auto.
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