Sebi's Franklin Templeton order sends ripples across MF industry

Fund houses to review investment processes; opt for safety over returns

The Securities and Exchange Board of India’s (Sebi’s) order directing Franklin Templeton Mutual Fund to return over Rs 500 crore of fund management fees is likely to instill fear and ensure strict discipline in the Rs 32-trillion asset management industry, said market observers.

Industry players said most fund houses could soon take stock of their investment practices in light of the Sebi order, which gives key insight into the regulatory thought process.

Since the 2018 IL&FS crisis and a spate of other high-profile corporate defaults, there has been significant regulatory tightening and risk aversion among fund managers. However, Sebi’s latest action will force the industry to further beef up systems. Liquidity management and strict adherence to investment best-practices are expected to gain prominence over return generation, experts added.

Dhirendra Kumar, CEO at Value Research, said: “This is a lesson for fund managers that managing liquidity is as important as controlling risk and returns. I think that fund managers will stop taking excessive risks while managing debt funds and will increase exposure in liquid assets. This may lead to a fall in returns.”

Sebi levied the penalty on Franklin MF for “several irregularities” in the running of its six debt schemes that were wound up in April 2020.

In the order, Sebi stated that Franklin MF was running its other debt schemes as credit risk fund schemes, defying the investment objectives of the schemes.

The order also stated that Franklin MF invested in illiquid securities without conducting proper due diligence and had made investments that were akin to giving loans to issuers.

Franklin MF had shuttered its six debt schemes in last April due to the severe market dislocation and illiquidity caused by the Covid-19 pandemic.

Industry players said the Franklin MF episode will change industry behaviour by letting the market forces play the course.

“FT had the option of selling the investments at below value, let the net asset value (NAV) collapse and return the money back to the investors when the crisis hit last year. However, they chose to freeze the funds. Going forward, if something like this happens again, fund houses may sell the papers at discount and return the money to investors,” Kumar said.

Joydeep Sen, a corporate trainer and author, said of the order that it seemed to suggest that fund houses should only play by the rule book, and not try anything that may potentially benefit investors. “If FT had sold the papers last year during the crisis, investors would have got lower returns. But there would not be any penalties or fines on them as they would have followed the rule book,” he said.

Domestic fund managers said Sebi has taken the right approach and its action will deter fund houses from taking undue risks.

In the order, Sebi highlighted that Franklin MF took exposure to stressed sectors and groups such as Essel, Reliance ADAG and Edelweiss despite early warning signals.

“One can’t just do anything wrong and get away. If some wrong decisions are taken against the interest of the investors, they will face the ire of regulators,” said a fund manager, who spoke on condition of anonymity given the sensitivity of the issue.

Industry officials said they will be more careful with the procedural aspects of fund management.

“The market regulator’s order lays emphasis on aspects such as documentation of investment decisions and security selection process, detailed credit analysis, monitoring of funds, and analysing the quality of promoters. Most fund houses will redraft their best practices after studying the Sebi order,” said another fund manager.