The Securities and Exchange Board of India (SEBI) has not only given fund managers the comfort of creating a segregated portfolio to separate the bad assets in a debt or money market scheme but also directed the trustees of the fund houses to ensure that such fund managers forego a part of their performance incentives for investing in assets that fall ‘below investment grade’ at a later stage.
“In order to ensure fair treatment to all investors in case of a credit event and to deal with liquidity risk, it has been decided to permit creation of segregated portfolio of debt and money market instruments by mutual funds schemes,” SEBI said in a circular issued on Friday.
“In order to avoid misuse of segregated portfolio, trustees shall ensure to have a mechanism in place to negatively impact the performance incentives of fund managers, chief investment officers (CIOs), etc. involved in the investment process of securities under the segregated portfolio, mirroring the existing mechanism for performance incentives of the AMC, including claw back of such amount to the segregated portfolio of the scheme,” it added.
On December 12, the board of the capital markets regulator had approved allowing fund houses to create such segregated portfolio — known as side pocketing in industry parlance.
The SEBI decision is largely triggered by the developments at IL&FS, which had defaulted on its various repayment obligations leading to a liquidity crisis across segments like mutual funds and non banking financial companies (NBFCs).
Side pocketing
The regulator had said that such a portfolio can be created only if there is a credit event at the issuer level in the form of downgrade of a debt or money market instrument to ‘below investment grade’ or subsequent downgrades from such levels.
SEBI had introduced the mechanism on an optional basis and fund houses desirous of creating such a ‘side pocket’ will have to seek the approval of trustees and inform within one day the decision of the trustees and also the impact on the investors.
“... till the time the trustee approval is received, which in no case shall exceed one business day from the day of credit event, the subscription and redemption in the scheme shall be suspended for processing with respect to creation of units and payment on redemptions,” stated the SEBI circular.
Further, all existing investors in the scheme will be allotted equal number of units in the segregated portfolio as held in the main portfolio and no redemption or subscription would be allowed in the segregated portfolio, the units of which would be listed on the stock exchanges within 10 working days to facilitate exit of the unit holders.
Meanwhile, the watchdog has warned fund houses that the option of creating a side pocket should not be looked upon as a sign of encouraging undue credit risks.
Any misuse of the provisions of segregated portfolio, would be considered serious and stringent action may be taken, stated the SEBI circular.
