Sebi allows MFs to side-pocket debt

Fearing a rush of redemption requests from investors in debt mutual funds as companies default on repayments, the markets regulator has allowed asset managers to sidepocket their exposures to entities that have approached them to restructure their debt.

Under the temporary rules that will be effective till the end of the year, asset management companies can side-pocket higher-rated debt and not just those below investment grade, the Securities and Exchange Board of India (Sebi) said in a circular issued on September 2. Sidepocketing was earlier allowed if there was a default or the debt was downgraded below investment grade.

The regulator is trying to help MFs deal with the turmoil caused by the pandemic and preempt a surge in redemptions forcing the asset managers to sell the underlying assets at a discount to pay investors.

With the six-month-long loan repayments moratorium drawing to a close on August 31, bad loans in India are likely to rise sharply to the most in 20 years.

“It’s a pre-emptive measure Sebi has allowed AMCs to take. Side-pocketing can prevent panic redemptions from the fund when there is news of restructuring because side-pocketed units cannot be redeemed,” said Mahendra Kumar Jajoo, chief investment officer, fixed income, Mirae Asset Mutual Fund.

Side-pocketing allows investors to recover investments in illiquid parts of their MF investment portfolio without having to resort to a distress sale of the underlying assets. Since redemptions are not permitted from side-pocketed units, funds pay investors when borrowers make repayments on the stressed debt.

RBI has already permitted lenders to restructure stressed debt of borrowers affected by Covid-19 related stress.

The regulator has appointed a committee under KV Kamath, a former CEO of ICICI Bank, to frame rules for debt recast.