Default in debt mutual funds prompts Sebi to look at tightening ruleshttps://indianexpress.com/article/business/default-in-debt-mutual-funds-prompts-sebi-to-look-at-tightening-rules-5701779/

Default in debt mutual funds prompts Sebi to look at tightening rules

The limits on the exposure that funds can take in debt securities issued by a single company and a corporate group could be reduced to provide higher diversification, sources said.

Default in debt mutual funds prompts Sebi to look at tightening rules
The regulator is also learnt to be closely watching the process followed by rating agencies in assigning credit ratings to some of these securities. (File Photo)

In light of recent defaults by various companies on their debt papers, to which several mutual funds had sizeable exposure, the Securities and Exchange Board of India (SEBI) is likely to revisit regulations relating to mutual funds to safeguard investor interests. Finance Ministry sources said the move comes after recent defaults in various fixed maturity plans (FMPs) by several mutual funds.

“Closed-ended fixed maturity plans pose serious risk to investors as there is no real time monitoring and investors are dependent only on the fund manager. We are discussing these issues and how regulatory loopholes can be plugged,” a senior official said. The market regulator is expected to review investment restrictions imposed on funds at the issuer level and sector level.

The limits on the exposure that funds can take in debt securities issued by a single company and a corporate group could be reduced to provide higher diversification, sources said.

As per existing SEBI rules, asset management companies need to ensure that the total exposure of debt schemes of mutual funds in a group does not exceed 20 per cent of the net assets of the scheme. This can extended to 25 per cent of net assets of the scheme with the prior approval of the Board of Trustees of the respective fund house.

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These limits, however, do not apply to investments in securities issued by public sector units, public financial institutions and public sector banks.

With total investment in a single group capped at 20-25 per cent at present, a debt mutual fund can pass the regulatory test even if it has only four to five securities in its portfolio. “This kind of concentration risk can be avoided by going for higher diversification,” the source said.

The regulator is also learnt to be closely watching the process followed by rating agencies in assigning credit ratings to some of these securities. Regulatory norms for investment in unrated debt papers are also expected to be tightened further, the sources said. Over the last month, there has been a debate on mutual fund exposure to illiquid debt papers. Though MF exposure to IL&FS Group companies in 2018 came as a setback to investors, missives from Kotak Mutual Fund and HDFC MF to their investors, earlier this month, resulted in a scare in the market.

Kotak Mahindra Mutual Fund acknowledged that its FMP Series 183 had almost 27 per cent of the scheme corpus invested in IL&FS Transportation Networks Limited and two Essel Group companies – Edisons Utility Works and Konti Infrapower & Multiventures. It said that as on September 9, 2018, the scheme had 7.37% of AUM invested in papers of ITNL and as on March 29, 2019, the scheme had 19.24 per cent of AUM invested in papers of Konti and Edisons. While the fund house had already written off investment in ITNL, it looked to assure the investors that it said that the fund house is working towards optimal recovery from two Zee Group companies.

The financials of Konti Infrapower and Edisons Utility accessed from Registrar of Companies showed that the Reliance Mutual Fund, Kotak Mahindra Mutual Fund and HDFC Mutual Fund had invested around Rs 950 crore in the two Zee Group entities in 2015-16.

In the meantime, while HDFC Mutual Fund was working hard to reassure its investors over exposure to Essel Group companies, the fund house reported fresh concerns on exposure of over Rs 230 crore in Hazaribagh Ranchi Expressway Limited, which defaulted on its debt obligations and forced the fund house to take a mark down of 37 per cent on its investment and accrued interest.

On April 14, 2019, HREL failed to honour principal repayment of Rs 12 crore (of the total investment of Rs 49.5 crore) due to HDFC Short-Term Debt Fund, along with interest amount of Rs 10 crore due to all the six investee schemes of HDFC MF. As of April 12, 2019, HDFC Mutual Fund had an aggregate exposure of Rs 232 crore, through six debt-oriented schemes, to NCDs issued by HREL.