SEBI Allows Mutual Funds to Create Side-Pocket in the Event of Debt Restructuring. Here is How it Will Help…
Listen to SEBI Allows Mutual Funds to Create Side-Pocket in the Event of Debt Restructuring. Here is How it Will Help…
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The six-month moratorium on outstanding term loans that RBI provided to borrowers in a bid to help them tide over the economic fallout from the pandemic ended on August 31. For borrowers who are still facing difficulties in meeting their payment obligations, RBI has allowed a one-time restructuring of corporate and personal loans for eligible borrowers without classifying them as non-performing assets (NPAs).
Pursuant to this, SEBI has decided that if a company decides to restructure its loans due to COVID-19 related stress, mutual funds will be permitted to side-pocket securities of such companies. The date on which AMCs receive the proposal for restructuring of debt will be treated as the trigger date for the purpose of creation of side-pocket (segregated portfolio).
On receiving the proposal for restructuring of debt, AMCs will have to report it to the Valuation Agencies, Credit Rating Agencies, Debenture Trustees, and AMFI immediately. As soon as AMFI receives such information, they will need to disseminate it to its members.
At present, mutual funds are permitted to create side pocket in case of a credit event (default or other similar situation), which results in downgrade of a security to below investment grade (BBB-). Now as per the circular, even those rated above investment grade can be segregated if the issuer opts for restructuring.
The circular has come into force with immediate effect and will be valid till December 31, 2020. All relevant provisions as per SEBI circular on 'Segregation of portfolio' as well as 'Prudential Framework for Resolution of Stressed Assets' will remain applicable for this purpose.
Notably, the provision of restructuring is only for borrowers facing stress solely on account of the pandemic impact. Credit rating agencies have been asked not to consider such cases as a default event and/or recognize default. RBI has allowed all lenders ofthe borrower to sign the Inter Creditor Agreement (ICA) to resolve stressed assets.
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What does it mean for debt mutual fund investors?
The new SEBI rule will allow mutual funds to follow a standard procedure when dealing with stressed assets arising due to the pandemic. Instead of selling the security, the fund could side pocket the exposure and prevent the NAV from taking the hit. It would ensure that only existing investors who had invested in the scheme at the time of the restructuring benefit from the recovery.
However, as an investor, keep a close watch on schemes having high exposure to such stressed assets. Restructuring of the loan could result in revaluation of security of the concerned company, which would impact the NAV of the scheme. Moreover, there is no certainty that the company would be able to recover from the COVID-19 setback even after restructuring of loans and repay the debt obligations. If this happens, it would be the investors who will bear the brunt of loss in value of asset.
What should investors do?
According to India Ratings and Research (Ind-Ra), banks are likely to restructure up to Rs 8.4 lakh crore of loans, or 7.7% of the overall system's credit. Over 60% of Rs 8.4 lakh crore could slip into the non-performing assets (NPAs) category, it added.
[Read: Why Investing In Debt Mutual Funds Turning Riskier]
Though the potential quantitative impact of stress that mutual funds may face is not known, you can protect your portfolio from any probable losses arising out of exposure to stressed assets. For this, it would be advisable to stay away from debt funds with high exposure to private issuers and prefer those that predominantly invest in government and quasi-government debt securities. Government and quasi-government debt securities enjoy high-credit rating and government backing which makes it highly liquid and less prone to credit risk.
Remember, that debt funds (including short duration funds) are not risk free; it is prone to credit, liquidity, and interest risk. Therefore, select schemes that align with your risk appetite, investment horizon, and investment objective. Further, to ensure that you invest in a worthy scheme, evaluate factors such as:
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The portfolio characteristics of the debt schemes
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The average maturity profile
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The corpus & expense ratio of the scheme
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The rolling returns
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The risk ratios
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The interest rate cycle
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The investment processes & systems at the fund house
At PersonalFN, we arrive at top rated funds using our SMART Score Model. If you wish to select worthy mutual fund schemes, I recommend that you subscribe to PersonalFN's unbiased premium research service, FundSelect.
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Warm Regards,
Divya Grover
Research Analyst
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