Mutual Funds

SEBI to soon issue detailed guidelines on side pocketing for mutual funds

The Securities and Exchange Board of India (SEBI), which had recently allowed mutual funds to create a segregated portfolio under their debt schemes that hold stressed assets, will soon be coming out with detailed guidelines on the same, its Executive Director SV Muralidhar Rao said.

“Considering the benefits of the side pocketing and the global scenario we have now decided to allow mutual funds to create a segregated portfolio with respect to debt and money market instruments subject to credit events. We are coming out with detailed guidelines shortly,” Rao said.

He was addressing the CII Mutual Fund Summit 2018 being held in Mumbai.

Side pocketing is a mechanism to separate the distressed assets or illiquid assets from the most liquid assets in a stressed scenario or any credit event.

Rao said side pocketing will stop redemption pressure in affected mutual fund schemes, prevent the fund managers from selling the illiquid assets at a distressed price and allow inflows from new investors with a new net asset value.

SEBI allowed side pocketing after multiple defaults by Infrastrucure Leasing and Financial Services (IL&FS), which came to light a few months ago and impacted liquid funds that held securities issued by it worth Rs 2,800 crore.

Rao pointed out that with the segregated portfolio, investors who may take the hit when the credit event happens will be able to benefit from the future recovery in the scheme.

Fund managers will be able to use the facility only in select credit events such as default in interest payment by the issuer.

Rao cautioned mutual funds that this facility should not mis-utilised and that all the necessary disclosures must be made to investors in a timely manner.

He also said that fund houses  must strengthen their in house credit risk assessment system for fixed income product instead of relying completely on ratings by the rating agencies.

Recently, SEBI Chairman Tyagi had said that side pocketing will protect retail investors.

As the defaulted paper will be segregated from the rest of the holdings, there will be two sets of net asset values (NAVs) of the affected mutual fund scheme. So, once the investments in the default papers are segregated, the scheme will be closed for subscription and investors will be able to continue to subscribe or redeem part of their investments in healthy assets.

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