Sebi letter ends MFs' hopes of joining DHFL resolution process

Regulator makes side-pocket mandatory for resolution process; over 100 exposed schemes fail to make the cut

The mutual fund (MF) industry's hopes of becoming part of the resolution process of Dewan Housing Finance Corporation (DHFL) under the inter-creditor agreement (ICA) framework got quashed on Thursday with the Securities and Exchange Board of India (Sebi) clearly stating that only those MF schemes that have already side-pocketed the affected debt exposure can participate in any ICA process.

Sebi was replying to a representation made by the industry body Association of Mutual Funds in India (Amfi), which had asked the regulator if the action of joining DHFL-ICA can itself be sufficient condition to side-pocket exposure to the troubled housing finance company.

However, Sebi's response means that more than 100 open-end schemes exposed to DHFL's debt papers won't be able join DHFL's ICA as they are yet to complete the stipulated process before side-pocket option can be availed of. The MF industry's exposure to DHFL stood at over Rs 4,000 crore. Overall, the systemic exposure to DHFL is Rs 90,000 crore, which is similar quantum to that of IL&FS.  

According to Sebi's letter, reviewed by Business Standard, "Segregation of portfolio pursuant to a credit event, in terms of Sebi circular dated December 28, 2018, should be pre-condition for signing ICA for the assets in the segregated portfolio."

"As per Sebi's direction, MFs can participate in future ICAs, but not DHFL. The same-day side-pocket rule has not been relaxed by the market regulator, so most of the exposed MFs will be out of this resolution process," said chief executive officer of a fund house, requesting anonymity.

As per Sebi's stance on ICA, only three schemes of Tata MF will be able to join DHFL's resolution process. Tata Corporate Bond Fund, Medium Term Fund and Treasury Advantage Fund are the only MF schemes that have so far side-pocketed the exposure. An email query sent to Tata MF on whether they would join the ICA framework for DHFL, didn't elicit any response at the time of going to press.

Meanwhile, legal route will continue to be an option on the table even for those MFs that initially opt for ICA framework for any distressed exposure.

"If the Resolution Plan (RP) imposes conditions on the asset management companies (AMCs), which are not in accordance with the provisions of  Sebi (Mutual Funds) Regulations and circulars ... AMCs shall be free to exit the ICA altogether with the same right as if it had never signed the ICA," Sebi's letter read.  

Amfi had sought clarity from Sebi on what should MFs do if RP terms restrict MFs from selling the debt securities or infuse further funds into the borrower. 

While MFs can exit if terms are not in-line with Sebi norms, MFs can also exit ICA if the RP is not implemented within 180 days of the review period. This provision is in-line with the Reserve Bank of India's (RBI) June 7 circular.

Subject to approval from board and trustees, MFs can at the most give extended timeline of 365 days for RP's implementation. As per RBI norms, the review period starts on the reference date, which is date when borrower is referred to ICA (i.e. June 29, 2019, in DHFL's case).  

Earlier, the MFs holding debt papers of DHFL were seeking one-time relaxation from Sebi on various regulatory provisions to to side-pocket exposures to debt-riddled company.

The norms require MFs to take side-pocket decision on the day of the credit event. However, when DHFL was downgraded to below-investment grade on June 5, 2019, MFs were not in a position to use the option as they had not completed the due procedures required as per Sebi regulations.

Apart from taking decision to side-pocket on day of credit event, the provisions also require MFs to give a 30-day load-free exit window to investors. Further, MFs need to put in place a detailed policy on the creation of a segregated portfolio, which is approved by the trustees.

Earlier, Insurance Regulatory and Development Authority of India had allowed insurers exposed to DHFL to become part of the ICA. The move had made MFs cautiously positive that Sebi would also allow them to join DHFL-ICA. 

Opening the gates 

• MFs can exit ICA in case resolution terms clash with Sebi regulations
• Legal route remains open for fund houses that join ICA process in future
• Only schemes that have side-pocketed affected exposure can participate in any ICA process
• Fund houses have sought clarity on impact of ICA on fixed maturity plans
• MFs instructed to keep investors’ interests in mind before any move 
• Only three schemes of Tata MF cleared to join DHFL resolution process