Set up special vehicle to give liquidity to MF: Group tells central bank

Distributor's association asks regulators to extend direct credit line for industry.

Foundation of Independent Financial Advisors (Fifa), a mutual fund (MF) distribution body, has demanded setting up of a special purpose vehicle (SPV) by the RBI to provide liquidity for the non-AAA investments of debt MF schemes.

"...Banks have provided liquidity to the AAA segment of the market and not to (the entire) space, which is stressed and facing liquidity issues. After the announcement of winding up of schemes of Franklin Templeton, the RBI announced further liquidity measures to provide liquidity to mutual funds, but this, too, has been provided via the banks,” the distributor body said in its representations to the central bank, the Securities and Exchange Board of India (Sebi), and the finance ministry.

Under the RBI window, banks can extend liquidity to MFs through three routes -- extending loans to MFs, giving out loans against collateral, and outright buying of commercial papers and debentures held by MFs. However, banks may refrain from extending liquidity through this window, given the asset quality concerns in their books and lack of good-quality collateral in the stressed portfolios of debt schemes.

“In the current scenario, an SPV can help bridge the liquidity gap. This SPV can also hold debt securities in their HTM or hold to maturity books to gain from the accruals. Franklin Templeton MF can also approach such an SPV to sell some of its non-AAA book, to expedite the process of repayments to investors,” said Dhruv Mehta, chairman of Fifa.

The note by Fifa pointed out that the Franklin episode had shook confidence of investors -- from corporate, high net-worth investors to retail investors -- and this could create another wave of panic redemptions in debt schemes, which need to be contained.

In a recent note, global rating agency Fitch has warned that there can be more ‘gating’ in debt schemes, if liquidity doesn’t reach fund houses. Gating entails suspension of fresh redemptions, which was one of the calls taken Franklin Templeton MF to deal with stress its portfolios. The agency pointed out that banks are likely to stay in the risk-aversion mode as they look at conserving capital, and curb asset quality risks in their books.