SEBI is absolutely correct on the need to regulate Debt Funds

The SEBI chairman recently underlined the need to regulate debt funds and FMPs in a more stringent way. While the contours of such regulation were not spoken about, the statement was clearly dictated by what had been happening to mutual funds in the last few months. Of course, we are talking about MFs unilaterally deciding to postpone the redemption of FMPs. How to regulate?

Greater disclosure is the key

FMPs and debt funds have a lot of leeways. In the last few years, there has been a glut of money flowing into MFs without adequate avenues to invest. The gap was filled by desperate promoters and fund managers willing to structure promoter lending via a pledge of shares. The whole problem is that such promoter funding requests are not disclosed by the fund. On the face of it, it looks like any normal bond investment and the problem explodes as it happened when the FMP comes up for repayment. Greater disclosure will call for making disclosure when shares are taken as a pledge, as soon as the promoter defaults on payments or when the bonds are downgraded. Above all, the key lies in educating retail and HNI investors about the risks of debt fund investing, especially with respect to credit opportunity funds and FMPs. The standards of disclosure required are quite poor today and as result funds are able to get away with an extremely opaque fact sheet; which says nothing!

Treat them like banks

One way to put the pressure on the mutual funds is to put them on the same regulatory space as the banks. As the SEBI chairman noted; mutual funds lending against promoter shares is nothing short of banking. That means; mutual funds must be subjected to the same degree of responsibility with respect to capital adequacy and asset recognition that banks are subjected to. There is a third possibility where the regulator must compel the sponsoring AMCs to take part of the responsibility for the losses caused to the investors. After all, when funds do charge a total expense ratio of 2% to 2.5% to investors, they must be held financially liable to make the losses that occur from such rash decisions of fund managers.

Fix individual accountability

Unlike bankers, fund managers are a fairly privileged lot as they don’t have to worry about the ED chasing them in case of loans gone awry. While that may not be required, you surely need greater accountability for fund managers, CIOs, and CEOs. More so, when it comes to taking rash decisions that are harmful to the interests of the unit holders. One can argue that such measures could be detrimental to the fund industry but SEBI is ultimately committed to the small investor and not to the fund manager. That should be the driving theme of debt fund regulation!