Speaking at a conference organized by a leading industry association, the SEBI had come down heavily on standstill agreements signed between mutual funds and borrowers. The SEBI chief rightly underlined that there was no provision in the SEBI MF regulations for such standstill agreements and asked mutual funds to make appropriate disclosures and provisions. Here is why this really matters.
Being more accountable
The SEBI chief was obviously talking with reference to the deal between the Essel Group and a clutch of mutual funds. These MFs, through their FMP schemes, had bought into bonds issued by Essel group companies. As an added surety, the promoter had also offered his personal shares as pledge. That is where the problems arose. This was more of loan against shares and SEBI felt that MFs were behaving like banks without the accountability of banks. The situation got exacerbated when the promoters of the Essel group could not honor the standstill agreement as on September 30th and asked for another extension of the standstill agreement till March 31st. While some funds have agreed to it, other funds have chosen to sell out; and rightly so. It is here that the SEBI chairman has expressed his unhappiness with the opacity of the standstill process. The SEBI chief rightly underlined that such agreements were outside the purview of SEBI.
Case against standstills
The SEBI chief has made two very important arguments against standstill agreements. Firstly, Tyagi has argued that standstill agreements are an unregulated way of postponing the issue. NAVs are supposed to reflect the market value of the portfolio as close as possible. However, when such standstill agreements are signed they do not reflect the fair value of the portfolio and to that extent they amount to value distortion. Secondly, SEBI feels that side-pocketing is a legitimate solution where the good portfolio is continued and the toxic portfolio is side-pocketed. This allows MFs to participate in ICAs but most MFs have not been too happy with the idea of side-pocketing.
Postponement is default
It is in this light that SEBI has modified this aspect of MF regulations. Under the new scenario, it is clear that any such standstill agreement will be treated as the equivalent of loan ever-greening. That means; the MF will have to make an immediate provision for default and adjust the NAVs accordingly. As SEBI rightly put it, such ever-greening tends to project the wrong picture of credit risk funds and make them look safe. The fact that promoters have asked for extension of standstill means that it was a wrong decision in the first place. After all, MFs owe their primary responsibility to unit holders and not to borrowers! ©