FRANKLIN TEMPLETON’S DEBT FUND QUANDARY: THE WAY AHEAD FOR THE INVESTORS AND ECONOMY
Updated: Jul 29, 2020
[Authored by Anurag Shah and Vijay Tarshit Nekkanti, 4th year BBA LL.B (Hons.) students at School of Law, CHRIST (Deemed to be University), Bangalore.]
Mutual funds industry that was already grappling with an economic slowdown and value deterioration of a number of industries and asset class has been served with yet another blow in the form of COVID-19 pandemic. The struggle for the mutual funds; which are considered “safe” against market fluctuations, is apparent from the news of Franklin Templeton India opting to wind up six of its debt schemes.
Franklin Templeton and the Six Funds
Franklin Templeton India cites reasons such as liquidity shortage behind winding up of these funds. These six funds are-Franklin India Low Duration Fund, Franklin India Dynamic Accrual Fund, Franklin India Credit Risk Fund, Franklin India Short Term Income Plan, Franklin India Ultra Short Bond Fund and Franklin India Income Opportunities Fund. This move has led to a whooping amount of Rupees 30,000 Crores of investor’s money being locked up. However, these six credit risk schemes have been facing redemption prior to the pandemic hitting India. The funds had to face an overall loss of Rupees 16,804 Crores in form of asset under management (AUM) between August 31, 2018 and March 31, 2020.
However, these losses surged as the Indian capital market fluctuated due the virus. So much so, that these funds faced a redemption pressure of Rupees 4,075 Crores between March 31, 2020 to April 20, 2020. The cause for this soaring redemption pressure directly co-relates with the liquidity crunch in the Indian Markets. As the economy was taking hits from the corona virus pandemic, the liquidity crunch forced Corporates and High Net worth Individuals (HNIs) to vigorously redeem these funds and recoup their cash shortages.
The reason why Franklin Templeton could not cope up with such an enormous redemption pressure is because these funds had been invested in high-risk instruments rated AA or lower. To compensate for such a low credit ratings, the borrowers pay higher interests, and thereby ensuring higher yields. But this then translates into higher risk for the lender because of the fear of a default. Now amidst an economic slowdown and a pandemic, papers that are rated AA or lower would rarely find any takers in the financial markets. After exhausting its available liquidity to absorb the redemption pressure, Franklin Templeton could not possibly, in present scenario, use the instruments to create further liquidity. This move was a final move and was undertaken only after Franklin Templeton had resorted to high borrowings from the Banks to absorb the redemption pressure. However, as stated earlier, the low ratings of the instruments made it difficult to find buyers in the market and this made things even more difficult. Therefore, on April 23, 2020, Franklin Templeton released a notice citing ‘dramatic and sustained fall in liquidity’ in the corporate bond market due to the COVID-19 and the resultant lockdown.
The Regulatory Framework pertinent to Winding Up of Mutual Fund Schemes-
The Primary regulations dealing with the winding up of Mutual Fund Scheme’s are encompassed under the SEBI Mutual Fund Regulations of 1996. Under the said regulations, regulations 39, 40 & 41 prescribe the circumstances and due procedure which is to be followed in case of winding up a said Mutual Fund scheme.
In this regard, considering that the 6 schemes under consideration are of open-ended nature, Regulation 39(2) prescribes that such mutual fund may be wound up, after repaying the amount due to the Unit holders in any of the following circumstances viz: -
· On the happening of any event which, in the opinion of trustees, requires the scheme to be wound up or
· If seventy-five percent of the Unit holders of a scheme pass a resolution that the scheme be wound up or
· If the Board so directs in the interest of the Unit holders
Having enumerated the circumstances therein, Regulation 39(3) prescribes for the issuance of a Notice disclosing the circumstances for winding up the scheme to the Board, two national papers and a vernacular newspaper in circulation at the place of issue of the Mutual Fund.
After ascertainment of the circumstances, Regulation 40 prescribes that on and form the date of publication of the aforementioned notice, the trustee or the asset management company shall cease to carry on any business activities, create or cancel any units and issue or redeem any units related to the wound up scheme therein.
Subsequently, as per Regulation 41 the trustee shall call for a meeting of the Unit holders to approve the decision of winding up by way of a simple majority, this compliance however is not necessary in cases where in such scheme is wound up at the end of the maturity period of the said scheme. In furtherance of the passing of resolution, the trustee or the person authorised shall dispose of the assets of the scheme in the best interests of the Unit holders.
Upon realisation of the assets, the proceeds of the sale realised shall be utilised towards, discharge of such liabilities as are due and payable, in meeting the expenses connected with such winding up and thereupon if any balance proceeds are available, the same should be paid to the unit holders in proportion to their respective interest in the assets of the scheme. Subsequently, the trustees shall bear the responsibility of forwarding a Report to the Board on the basis of explaining the utilisation of the assets in the process of winding up the scheme. However, it is safe to peruse that, in the erstwhile of process of winding up, the disclosure requirements pertinent to furnishing half-yearly reports and annual reports shall stand to be unfettered.
Response of the Reserve Bank of India-
It is pertinent to note that the Asset Management Company in question had cited the issue of lack of Liquidity to facilitate extraneous amounts of Redemption requests as one of the key factors driving its decision towards shutting down its 6 debt schemes. However, right from the onset of expressing its concern, the Reserve Bank in view of instilling investor confidence and protecting the Mutual Funds market as whole, had been acting proactively so far.
In the Central Bank’s initiative vide press release date April 27, 2020 it has in the view of easing liquidity pressures on Mutual Funds, decided to open a special liquidity facility (SLF-MF) for mutual funds of amounting to ₹ 50,000 crore. Under the said scheme, the RBI shall conduct repo operations of 90 days tenor at the fixed repo rate in an on-tap and open-ended basis, wherein banks can opt for the said scheme until the 11th of May 2020 or up to utilization of the allocated amount, whichever is earlier.
The said press release also adequately addressed a genuine concern that the eligible Banks may have regarding the respective Capital Market exposure limits, wherein it clarified that the Liquidity support availed under the SLF-MF would be eligible to be classified as held to maturity (HTM) even in excess of 25 per cent of total investment permitted to be included in the HTM portfolio, the exposures under this facility will not be reckoned under the Large Exposure Framework (LEF) and that the face value of securities acquired under the SLF-MF and kept in the HTM category will not be reckoned for computation of adjusted non-food bank credit (ANBC) for the purpose of determining priority sector targets/sub-targets. Thereby clarifying that the support so extended to Mutual Funds under the SLF-MF shall be exempted from banks’ capital market exposure limits.
In further broadening the spectrum, the Central Bank vide its press release date April 30, 2020 clarified that the regulatory benefits announced under the SLF-MF scheme will be extended to all banks, irrespective of whether they avail funding from the Reserve Bank or deploy their own resources under the above-mentioned scheme.
Most of the regulatory process is being followed up by Franklin Templeton, even though it is difficult to it given the lockdown. Therefore, Franklin Templeton has arranged for e-mail confirmation facility for the unit-holders to confirm their acceptance. The most important concern of the investors who have always been advertised that mutual funds are “safe” is about the future of their investments in these six debt funds of Franklin Templeton. And the story does not have its end here, as the Indian capital market has proven to be risk averse, and also because of the present lockdown and market fluctuation, closing of these six schemes could lead to a panic in the mutual funds market and thereby increasing the redemption pressure and consequently decreasing the liquidity in market further.
However, this where the investors need to understand that the move by RBI to create a liquidity window would bring the equilibrium back in order. Moreover, the investments that are involved in the six schemes, even they will find their way back to their principals mostly after the maturity period. It is also pertinent to understand that the process of winding up is not one which solely vests the trustees with an arbitrary authority at the plight of the unit holders. The process of winding up is a broader concept which stands effected on through the consent of the unit holders as aforementioned. As of now it is a suspension of redemption, which is one of the security risks envisioned under the offer document of the schemes. Therefore, the investment, even though in a staggered manner, would eventually be returned. And even the regulatory body, SEBI has launched probes into the matter. However all of this has to be taken with a pinch of salt that investors can expect recovery but it will be after facing an anxious wait primarily because of the different maturity periods and the unconventional market conditions now.
[A] Franklin Templeton India Notice of winding up available at https://www.franklintempletonindia.com/downloadsServlet/pdf/notice-of-winding-up-final-230420-k8lf815l
[B] Reserve Bank of India, Press Release April 27th, available at https://m.rbi.org.in//Scripts/BS_PressReleaseDisplay.aspx?prid=49728
[C] Reserve Bank of India, Press Release April 30th, available at https://m.rbi.org.in//Scripts/BS_PressReleaseDisplay.aspx?prid=49746