Pledging mutual fund units

Investors can pledge their units as security to financiers like banks and financial institutions and borrow against their mutual fund units.

To do so, a lien has to be marked against the units. Lien refers to the right of the financier to take and hold or sell the property of a debtor as security or payment for a debt. We discuss the process of marking a lien on mutual fund units.

An investor can approach a financier or a banker for a loan or overdraft facility sanctioned by pledging his or her mutual fund units as security.

The person should then send a letter to the mutual fund/ registrar requesting the fund to mark a lien on the units in favour of the financier.

The letter should state the name of the investor as mentioned in the mutual fund records, the folio number, the scheme and the number of units for which lien is to be marked.

Unit holders should sign according to their mode of holding or it should be signed by all holders if the fund is held by jointly.

A a letter from the financier verifying the above is also needed. If the investor is not an individual, then the board resolution/partnership deed authorising the relevant person for pledging the mutual fund units should also be submitted.

A lien is marked on units and the request to mark lien will be rejected if only an amount is mentioned in the letter. The fund/scheme/number of units mentioned in the letter from the financier should tally with that of the investor.

The number of clear units available for marking lien (for example, units not locked because they belonged to a tax-saving schemes, etc.) should be equal to or more than the number of units pledged.

The registrar will mark the lien and a letter will be sent to the financier with a copy to the investor confirming the marking.

Removal of Lien

The financier can ask for the removal of the lien and send a request letter to the fund.

This request should clearly state the name of the investor, fund, folio number, scheme and the number of units for which the lien should be removed. A financier can also request for a partial removal of lien in which case lien on some of the units will be removed. These units are called free units. This can happen when financiers receive partial payments.

If the financier in the letter of request for marking a lien mentions only the number of units which are to be marked, it is a normal lien. This would mean that any dividends reinvested or any future accrual in the scheme would be free and not under lien. However, if the request states that future accruals to the investment such as dividend reinvestment are to be marked under lien, then it is called dynamic lien.

Enforcement of Lien

If the borrower defaults in making payments, the financer can enforce the lien, that is, send a signed request to the mutual fund to redeem the units and the mutual fund will send the proceeds/cheque to the financier.

(Contributed by CAMS Viveka, Investor Education Team of CAMS. The views expressed here are general practices in the mutual fund industry and may vary according to the case.)

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