Sebi-Amfi meet to discuss Mutual Fund, debt fund regulations

The Securities & Exchange Board of India (Sebi) has called a meeting with top officials from the mutual fund industry to discuss issues related to debt funds and specifically credit funds.

In the meeting, scheduled for March 4, the Association of Mutual Funds in India (Amfi) will request the markets regulator to come

out with regulations on creation of ‘side pocket’ for all debt funds as a prudent measure.

A ‘side pocket’ option allows fund houses to separate stressed or risky assets from other liquid investments in a debt portfolio which tends to get impacted by the credit profile of underlying instruments.

“Though upgrades and downgrades are part of every corporate bond portfolio, we have seen only one default last year. But given the grim situation today, we don’t want to take any chance and that is the reason we will ask the regulator to allow fund houses to create ‘side pocket’,” said a senior Amfi official.

In the meeting, Sebi will also discuss mutual funds’ long-term policy with Amfi.

Last year, JP Morgan Mutual Fund adopted the ‘side pocket’ option after it had faced redemption because of its Rs 200-crore exposure to Amtek Auto, which had seen sudden rating downgrade from credit rating agencies.

JP Morgan Mutual Fund had restricted redemption from two of its debt schemes — Short Term Income Fund and India Treasury Fund. The move came in the wake of a decline in net asset value (NAV) of the schemes due to fund house’s exposure to Amtek Auto’s debt papers.

Recently, the industry faced similar concerns after credit rating of Jindal Steel & power (JSPL) witnessed several downgrades, leading to substantial fall in NAVs of schemes having exposure to debt papers of JSPL.

Market players say once advance creation of ‘side pocket’ is allowed, there will be less problems faced by investors in case of a default.

“In the current regulatory framework when there is crises, fund houses need regulator’s permission to create a ‘side pocket’ and few days are lost. But if Sebi formalises this proposal, fund houses can immediately create a ‘side pocket’ after the approval from trustees, and investors can redeem their money from liquid portfolio of the scheme,” says another member from Amfi.

In the past few months, credit quality of portfolios of debt mutual funds has come under the scanner following multiple notches of rating downgrades of a few companies.

There are concerns that such consistent revisions pose a grave risk to the performance of credit funds also as in the last couple years, composition of such funds has moved towards lower-rated papers. According to a note by ICICI Direct, in search of higher yields, a significant part of record inflows in credit funds has flowed into ‘A’- and ‘AA’-rated corporate bonds.

It estimates that the accumulated corpus of ‘A’- and sub-‘A’-rated securities across schemes has increased from Rs 5,000 crore to Rs 22,500 crore in the last four years. Similarly, the cumulative exposure to

‘AA’-rated securities has increased from Rs 2,900 crore to Rs 17,000 crore during the period.