India Orders Mutual Funds Not to Shield Stressed Companies

(Bloomberg) -- India’s market regulator prohibited mutual funds not to sign pacts with stressed companies that delay margin calls, because such deals hurt investors.

The Securities & Exchange Board of India’s ban comes after companies such as Essel Group reached so-called standstill agreements with money managers. Under such deals, fund managers agree not to sell shares pledged by the founders as collateral for loans even if the stock tumbles. India’s biggest money manager earlier this month said it will spend 5 billion rupees ($72 million) to shield investors in some of its funds that own debt issued by the Essel Group.

“Mutual funds are not banks, so there’s nothing called standstill,” Sebi Chairman Ajay Tyagi said at a briefing in Mumbai on Thursday “They are investing, not lending. There has to be more discipline and prudence in the industry to protect investors’ money.”

The standstill pacts could lead to funds assuming a financial risk. While HDFC Asset Management Co. agreed to bailout investors, smaller rival Kotak Mutual Fund in April said it expects to recover money from Essel with some delay. Essel Group, whose firms include the flagship Zee Entertainment Enterprises Ltd. signed a pact with lenders in January not to classify its debt as default until Sept. 30 to provide the group with time to sell assets and repay debt.

Read more about HDFC’s bailout plan for Essel bonds

“Mutual funds can no longer hold back investors’ funds and need to repay them, when the plan matures irrespective of the pacts,” said Kaustubh Belapurkar, director of manager research at the India unit of Morningstar Investment Adviser. Funds will have to sell pledged shares if the companies default, he said.

Here are the other changes announced by Sebi.

• Liquid plans will compulsorily hold at least 20% in assets including cash, government bonds, T-bills
• The way funds debt and money-market instruments has been changed -- valuation will be made on a mark-to-market basis, and not on amortization basis done previously
• Liquid/overnight plans can’t invest in short-term deposits, debt and money market securities with structured obligations or credit enhancements
• Funds mandated to invest in only listed non-convertible debentures; all new investments in commercial papers and equities will also be allowed only in listed securities
• Sector caps for liquid funds reduced to 20% from 25%
  • Additional exposure of 15% to housing finance cos. reduced to 10% in such firms, and 5% in securitized debt based on retail and affordable housing-loan portfolio

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