In 2014 when the then SEBI chief U K Sinha proposed an increase in the net worth of mutual fund Asset Management Companies (AMCs) by 10 fold to Rs 100 crore, he was greeted with a wave of opposition by the industry and many in the business media. Finally the regulator pushed through a 5-fold increase to Rs 50 crore. Under Sinha the SEBI had also mandated that AMCs must invest seed capital of 1% of the corpus in all their funds to ensure some skin in the game. The time has probably come to reconsider what the former regulator wanted – ie; increase the skin in the game of the AMCs by either increasing their net worth as Sinha wanted or increase their seed capital or both.
The going has been extremely good for mutual funds since 2017 and in good times, the financial sector is wont to become complacent. But there are simply too many red signals now for the industry or the regulator to ignore. The IL&FS downgrade and eventual implosion is not a one-off as we now realize. The Essel group has come public with its problems and DHFL’s woes aren’t ebbing away. Yes SEBI has allowed “side-pocketing” as one measure to tide over sudden defaults of one-odd instruments. But more clearly needs to be done. The basic vulnerability of the debt fund model to convert one-day money into 3-month or 3- year money, the quality of its due diligence and risk assessment and the extent of its disclosures all need to be reviewed.
For starters the regulator needs to re-open the debate on whether both net worth and seed capital levels need to increase. Too many large funds have taken too many risky bets with investors’ money. The fund industry will be well placed not to stonewall this idea like they did with U K Sinha. Corporates who had until recently merrily outsourced their cash management to mutual funds are now facing tough questions from their boards. Already chief financial officers of most large treasuries are being pulled up by their boards for investing in risky funds just to get 10-20 basis points more of returns. If the fund industry came forward and voluntarily agreed for more seed capital, it will reassure corporate investors. While the extent of increase in net worth or seed capital can be argued, the need for a debate is imminent.
Likewise, the regulator needs to force mutual funds to sell risky funds responsibly. It may impose a large entry level for Credit Risk funds like say one crore rupees, so that these funds are not sold to retail investors. It could also ask for additional disclosure : Besides saying that mutual funds are subject to market risk, SEBI must also require credit risk fund documents to carry a disclosure prominently that : there is no guarantee that capital won’t be eroded. This will alert unsavvy investors to whom credit risk mutual funds are being sold like bank fixed deposits.
More rules probably need to be written for Liquid mutual funds: they have been continuously asked to bring down their maturity profile to 60 days. May be the time has come to bring it down further to 30 days. More important they need to be told to keep a small percentage of their assets in cash or near cash instruments. The Reserve Bank has been separately indicating that new asset-liability rules are being written for Non-Bank Finance Companies. Some kind of liquidity coverage ratios (keeping a percentage of their funds in cash or near cash instruments) will most likely feature in the new rules.
More generally the capital markets regulator and the mutual fund AMCs need to take a macro view of the industry and see if sufficient counter cyclicality is built in. Are any stress tests of the portfolios being done? Are risk departments well-staffed? To whom does the risk officer report? Does she report directly to the board or the trustees? And have the trustees asked their managements tough questions about the quality of the paper they invest in and the disclosures they make, especially to retail investors?
The SEBI had earlier proposed sector-wise exposure limits on mutual funds. But have mutual fund trustees written rules or even checked the concentration-risk in their funds- both equities and debt to sectors and specific companies and at industry-level, fund house level and fund-level? If they haven’t, the regulator better mandate them to do so. Sebi and the trustees need to sensitise or even mandate fund managers to link exposures to the economic cycle. Banks have stricter exposure limits despite the fact that they have more reliable liability franchises and lender of the last resort back up. Mutual funds have neither.
Fund managers took home huge bonuses when the going was good, but now it is pay back time. May be SEBI can also write some rules on bonus claw backs? This may be a good safety belt in good times when fund managers mistake a random market movement (in the post demo year) as their own investment genius. There has been a lot of cheerleading of the financialisation of savings in India. It is time to ensure this financialisation is a stable upward sloping curve.
First Published: Feb 3, 2019 5:43 PM IST
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