Editorial

Debt trapped

| Updated on June 08, 2021

The Franklin Templeton issues has shown up SEBI’s lapses too   -  REUTERS

SEBIs order on FT exposes lacunae in MF regulation and is a warning for other funds

After being abruptly locked out of their debt funds last April, investors in the six wound-up schemes of Franklin Templeton India (FT) have been groping in the dark about what really transpired. In the event, the Securities Exchange Board of India’s (SEBI) recent orders against the Asset Management Company (AMC) and its senior officials shed light on what precipitated the crisis and what can be done to avoid such mishaps in future.

SEBI’s order suggests that it was FT’s single-minded pursuit of high yields in its debt schemes that led it to it glossing over liquidity, concentration and credit risks. One (it alleges), though mutual fund categorisation norms require individual schemes to have distinct features, FT ran all of the six debt schemes essentially as ‘credit risk’ schemes with high exposure to lower-rated and unlisted securities. FT was also the main subscriber to several ‘bespoke’ issues with complicated structures. Given the difficulty of finding counter-parties, such bonds are at the outset a poor fit for short-term debt funds bought by liquidity-seeking investors. Two, FT down-played interest and credit risks in its structured bonds by valuing them based on their interest reset date rather than actual maturity. It isn’t clear why independent valuation agencies didn’t flag the issue. Three, in its keenness to retain high-yield paper, FT often avoided exits and granted moratoriums to issuers, kicking the can down the road. All these findings suggest that both default and liquidity risks were inherent to the investment strategies pursued by FT and cast doubts over its claim that its liquidity crisis was triggered by Covid. In a separate order, SEBI has also found that a senior FT official, Vivek Kudva, and his wife, while being in possession of non-public information about the debt schemes’ troubles, indulged in unfair trading practise by redeeming their units just before the schemes were wound up.

FT’s case serves as a cautionary tale to other AMCs against letting star fund managers enjoy carte blanche without adequate oversight. It also raises questions over the efficacy of SEBI’s inspection mechanism for AMCs, which mandates frequent filings on transactions and portfolios. It beats understanding as to how SEBI allowed FT to run all its debt schemes as credit risk funds while being widely mis-sold as FD substitutes. This case has also exposed lacunae in SEBI’s mutual fund regulations on borrowing limits and the winding up process, and also the absence of insider trading rules for mutual funds. These gaps need to be plugged. It remains to be seen if SEBI’s disgorgement orders on the AMC and its officials, survive the appeals process. Such orders are usually reserved for cases of fraud or unlawful gains, but the FT orders only make a case for negligent/unethical/unfair conduct. Given this, the AMC and its officials may get away rather lightly despite the widespread damage they’ve inflicted on investors.

Published on June 08, 2021

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