Sebi says mutual funds can use 'side-pocket' for unrated debt

Market regulator clears grey area for exposures not graded by rating agencies

The Securities and Exchange Board of India (Sebi) on Thursday issued a circular clarifying that a side-pocket could also be created in the case of unrated debt instruments.

The circular said that in the case of such instruments, side-pocket can be created only when there is an 'actual' default on the principal or interest payment.

Earlier, guidelines laid down by Sebi say that side-pocket can be created when there is a credit event, i.e. downgrade of an instrument to below-investment grade. However, there was no explicit guideline for an unrated debt, where the side-pocket rule could not be triggered by a rating action.

"The circular makes it clear that a fund house can create a segregated portfolio or a side-pocket for both rated and unrated debt instrument. There was a grey area on unrated debt exposure," said a fund manager.

Also, to make sure that one fund house does not get an unfair advantage on knowledge of the default, the regulator wants fund houses to immediately inform about the development.

"Asset management companies shall inform Association of Mutual Funds in India (Amfi) immediately about the actual default by the issuer. Upon being informed about the default, Amfi shall immediately inform the same to all AMCs," the circular read.

"Pursuant to dissemination of information ... about actual default by the issuer, AMCs may segregate the portfolio of debt or money market instruments," it added.

Further, Sebi said that all new schemes launched in future, must already include all the provisions in the scheme information document that state the possibility of using side-pocket mechanism.