SEBI’s idea of AMCs funding their own backstop is a good one

The Chairman of Securities Exchange Board of India (SEBI), Ajay Tyagi, raised pertinent points about debt mutual funds in his recent address to Association of Mutual Funds of India. After congratulating the industry on adding retail assets at a brisk race, he flagged the risks to those very investors arising from liquidity issues cropping up frequently in debt funds. Referring to Franklin Templeton freezing investor payouts by abruptly shuttering six open-end schemes, Tyagi mooted three possible measures to prevent a repeat. He suggested a backstop entity that would buy out illiquid corporate bonds from debt funds during stress, with skin in the game from industry players. He proposed an advisory committee to come up with mechanisms for stress-testing and swing pricing of debt funds. Interim rules will meanwhile be framed requiring all debt funds to park a minimum proportion of their assets in liquid instruments. All this has attracted predictable pushback from debt fund managers, who complain that creating a backstop facility of adequate size will pose practical difficulties and that holding liquid instruments would dilute returns.

But such complaints divert focus from the structural anomaly in open-end debt schemes that promise anytime liquidity to their investors, while investing mostly in illiquid corporate bonds. This conundrum is bound to crop up time and again hurting investors, unless SEBI finds lasting fixes to it. In recent years, domestic AMCs have amassed debt assets of ₹12.6 lakh crore and pocketed handsome fees, from selling ‘high-yield’ funds that dabble in illiquid corporate bonds. The problem of bunched-up redemptions in such funds is also of the industry’s own making as it has actively wooed opportunistic corporate treasuries and HNIs to these funds. Now it is only fair that the industry foots the bill to ensure that these funds fulfil their promise of anytime liquidity, instead of knocking at regulators’ doors every time there’s a crisis. The RBI’s latest MF liquidity window marks the third occasion on which it has had to bail out the industry after the crises of 2008 and 2013, raising questions of moral hazard.

Arriving at the appropriate size for a backstop entity is hardly the challenge. It can amount to, say, 20 per cent of the ₹1.5 lakh crore assets managed by credit risk and corporate bond funds, with every AMC contributing in proportion to the assets it manages. If the industry feels that such a backstop is difficult to fund, it needs to curtail corporate debt funds managed in the open-end format and move to a more manageable close-end format. SEBI can also look at allowing debt funds to gate redemptions for limited periods and apply investor-level caps on fund holdings to prevent bunched-up outflows. Many of these issues would sort themselves out once India’s corporate bond market attains a reasonable stage of development. For this, SEBI needs more active support from the Centre and RBI.