Mumbai: The board of capital markets regulator Securities and Exchange Board of India (Sebi) will discuss on 13 December whether mutual funds (MFs) should be allowed so-called ‘side-pocketing’ where liquid schemes separate their risky securities from the rest, two people aware of the matter said. The board may also clear norms for easier listing of start-ups at the same meeting, the people mentioned above said on condition of anonymity.
Side pockets separate stressed or risky assets from other investments and cash holdings. Having them ensures that while some of the investor money in a mutual fund liquid scheme linked to stressed assets gets locked until the fund recovers money from the stressed company, investors can redeem the rest of their money if they want.
Side pockets were first used by JP Morgan Asset Management (India) Pvt. Ltd in 2015 when a ratings cut on Amtek Auto Ltd’s bonds that it held triggered a crash in two of its funds’ net asset value. Investors rushed to redeem their money, prompting the fund house put restrictions on them.
An email sent to the markets regulator on Tuesday was not answered immediately.
According to the first of the two people cited above, serial defaults at Infrastructure Leasing and Financial Services (IL&FS) and its impact on liquid funds that held IL&FS securities worth ₹2,800 crore prompted the regulator to initiate a review of risk management measures for liquid funds. “The review was undertaken by the Mutual Fund Advisory Committee (MFAC) which has recommended in favour of a so-called ‘side pocket’. The norms will have some caveats so that it does not become a moral hazard with fund managers taking riskier bets. The caveats would be at what value the bond should be placed in a ‘side-pocket’,” said the second person.
“While in 2016 Sebi refused to standardize the practice, it is revisiting the idea in the wake of the IL&FS crisis and the general pressures on bonds issued by non-banking financial companies and housing finance companies,” said the second person.
“Side pocketing may work in India in insulating risky assets as there is general lack of liquidity in the bond market. But the flip side is that it can have a parachuting effect and asset managers could end up taking riskier bets,” said Kaustubh Belapurkar, director of fund research at Morningstar Investment Adviser India Pvt. Ltd.
“Side-pocketing as a norm will end up creating a moral hazard and also make fund managers complacent towards future credit defaults. But for some specific issues, like the current IL&FS issue, it may be looked at as an stop-gap option,” said Arvind Chari, head of fixed income and alternatives at Quantum Advisors.
Typically, bonds are marked to market; however once they fall below investment grade, the valuation committee of the mutual fund does the work.
“There is no standard practice for mark-to-market for papers that have fallen below investment grade. The regulator is discussing whether some standardisation can be introduced,” said the first person.
Also, Sebi might ask fund managers to talk to the issuers directly before investing or purchasing their paper. “This is to reduce excessive reliance on credit rating agencies,” said the second person.
The Sebi board will also consider startup listing by tweaking the Institutional Trading Platform (ITP). This is based on a panel report submitted in October.
“In order to be eligible for listing on the ITP, 25% of the pre-issue capital, for at least a period of 2 years, should have been held by Qualified Institutional Buyers/other regulated entities and/or Accredited Investors (AIs), of which not more than 10% should be by AIs,” said Sebi in its discussion paper.
Sebi is also expected to reduce the minimum trading lot size from ₹2 lakh from the existing ₹10 lakh. The minimum number of allottees will be revised to 50 from the existing 200. Besides, It has also proposed ₹10 crore as minimum net offer size to public.