In our previous article, we had discussed about AMCs (asset management companies) buying out debt from their schemes (i.e. funds) in extreme situations. From the perspective of market regulator SEBI’s regulations, this is a grey area, as there is no specific rule that explicitly allows or prohibits an AMC from purchasing securities from its schemes. Let us look at the background, and understand why we require a policy on such purchases.
In 2016, Franklin Templeton purchased approximately Rs 1,500 crore of Jindal Steel and Power’s (JSPL’s) debt papers in its books. These were purchased in two tranches in January and February 2016. Recently, HDFC AMC notified the purchase of Rs 500 crore of Essel Group loan-against-shares (LAS) exposures from FMPs maturing during the period April to September 2019. When a takeover of disturbed debt happens, the pricing is obviously on the lower side, reflecting the poor credit quality of the holding.
Valuation of debt securities
In 2016, there was no CRISIL/ICRA valuation of debt below investment grade rating. JSPL was taken over by FT (Franklin Templeton) AMC at a discount of about 35 per cent from the schemes—at a valuation of around Rs 1,000 crore against the face value of approximately Rs 1,500 crore. In the current context, valuation for all securities, including for those below investment grade, is provided by industry body AMFI-approved valuation agencies—CRISIL and ICRA. Hence, when HDFC AMC takes over Essel Group’s LAS exposures, it will be at a valuation provided by CRISIL & ICRA.
The two entities—Edisons InfraPower & Multiventures Pvt Ltd and Sprit Infrapower & Multiventures Pvt Ltd—are rated BBB (just investment grade) by Brickwork Ratings, as per a release dated June 13, 2019. These are the two papers that HDFC AMC will take over from the schemes. Even JSPL is back to investment grade rating, which was downgraded to D (default) earlier, during the troubled times. The point of debate is, if and when the JSPL and Essel entities pay up their dues, who gets to keep the profit?
The profit in this case means the difference between the (relatively lower) price at which the instrument is taken over by the AMC and the price paid by the issuer on maturity. Is it for the AMC to keep, as it held the exposure, took the risk and is thus entitled to the profit, if any? Or, is it supposed to be given back to the schemes, for had the exposure not been taken over by the AMC, the profit would have accrued to the unit-holders? If the gain is to be given back to the schemes, does it belong to the current unit-holders or unit-holders at that point of time when it was taken over?
This is not to say all doubtful exposures taken over by an AMC from its schemes are profitable. There have been many instances earlier that loss-making proposals have been taken over by AMCs for protecting their goodwill, though it was not required by law. For the sake of clarity, what we require are guidelines from SEBI to decide on:
- Whether an AMC can or cannot purchase securities from its schemes
- Who takes the profit or loss, the AMC or the scheme
- If the gain/loss is to be taken by the scheme, then is it the current investors or ones at the time of take-over who get to keep the profit or suffer the loss?
It will be dicey if there is a loss and it is to be passed on to the scheme. Neither existing nor earlier unit-holders would want to take a loss from an earlier forgotten event.
The stance of the market regulator SEBI in this context is, in a way, implied. Guidelines relating to side-pocketing, technically known as segregation of portfolio, are in place. Side-pocketing clarifies these issues: in case of any stressed debt exposure, all market events – profit or loss – belong to investors, as mutual funds are market-related pass-through-vehicles and the AMC is not supposed to step in.
Side-pocketing also ensures that any recovered amount in the future belongs to the unit-holders who bore the risk and not to the ones who came in subsequently. However, segregation of portfolio is not compulsory and the Scheme Information Document (SID) should contain the enabling provision. And that leaves an open area for discussion: if a scheme suffers a credit-related event and the SID does not have the enabling provision for segregating the portfolio, what can the AMC do?