Lifeline for MFs: PMO suggests steps for resolution of stressed assets

Writes to DEA and Sebi for Covid-19 support fund for closed-ended debt schemes

The Prime Minister’s Office (PMO) has suggested regulatory steps and liquidity to help mutual funds (MFs) that have exposure to stressed companies. 

These include setting up a Covid-19 Support Fund for closed-ended debt schemes. Such schemes do not permit entry and exit for investors till the end of tenure.

The move could throw a lifeline to asset management companies (AMCs) that have been plagued by a liquidity crisis, mostly on the debt side, for the past two years, starting with the Infrastructure Leasing & Financial Services fiasco. The crisis was exacerbated by Franklin Templeton’s decision to shut down six debt schemes, with assets of more than Rs 30,000 crore.

In a seven-page letter to the Department of Economic Affairs and Securities and Exchange Board of India (Sebi) early this month, the PMO asked them to resolve the problems of stressed assets. 

Other proposals include relaxation in the pricing mechanism for companies undergoing restructuring/insolvency, modifying side-pocketing (separating good assets from bad by creating a portfolio) norms, giving a scheme 15 days to create a portfolio and not having to do it immediately, as is the case now, and rights to debenture holders in case of default.

“The intensifying Covid-19 pandemic and a looming global recession have cast an unprecedented cloud over the credit quality outlook of India Inc, which has already been impacted by a slowing economy,” the PMO said.

“This has forced economists to reduce the base-case gross domestic product growth forecast for 2020-21. The slowing economy would bring in financial stress over near to medium term. However, credit quality trends would be driven by resilience of companies in terms of bouncing back from the near-standstill demand situation,” the PMO said in the letter.

Referring to the letter, the Association of Mutual Funds in India (Amfi), an industry body, said that closed-ended schemes could not do segregation or side-pocketing, and it was unclear whether such schemes could sign inter-creditor agreements (ICAs) and participate in the resolution process.

“It would be useful to clarify that closed-ended schemes may participate in resolution processes. For such schemes, Sebi, along with the Reserve Bank of India and Ministry of Finance, may set up a Covid-19 Support Fund to support the mismatch arising out of the resolution process,” the letter said.

In August last year, Sebi allowed AMCs to sign ICAs but on condition that good and bad assets were segregated. This was done in the wake of exposure to debt instruments of cash-strapped Dewan Housing Finance (DHFL). 

Also if the resolution plan is not executed in 180 days, the AMC may exit the ICA and fund houses are free to take legal recourse if its departure contravenes the terms of the ICA.

According to the PMO, the process of participation should be unconditional.

“Since a resolution process contemplates collective action rather than enforcement, it is imperative that participation of the fund house in the process is unconditional and individual enforcement action is discentivised while the resolution process is on,” the letter noted.

Sources in the Amfi said that none of the MFs was party to any such agreement and they were working with banks to settle matters related to episodes such as that of DHFL. The reason for this is that the resolution process may end up violating the mandate of some of the schemes. Also, AMCs have to evaluate whether it is in the best interests of unitholders to participate in ICAs.

For instance, if a restructuring plan involves converting debt into equity, it may end up violating the scheme mandate. MFs say they are not sure if the markets regulator would allow this even after side-pocketing has been done. In a similar context, the PMO has raised the point there is considerable ambiguity whether debenture trustees (DTs) can sign an ICA and, if so, on their manner of seeking the approval of debenture holders. 

The PMO is of the view that DTs’ participation in ICAs will give them a seat as well as minority protection through liquidation value if they vote against a resolution plan.

The PMO said the 15-day window for creating a separate account would enable MFs to decide on action to be taken in line with peer investors/creditors. The letter sought tweaking the pricing mechanism under Sebi’s Issue of Capital and Disclosure Requirements, and said that they might be relaxed for investors/creditors acquiring companies undergoing resolution.