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SEBI notifies new trigger date for creation of segregated mutual fund portfolios

Finsec Law Advisors

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On September 02, 2020, SEBI issued a circular revising the trigger date for creation of segregated portfolio of debt and money market instruments by mutual funds’ schemes (Circular). Through the Circular, SEBI has allowed mutual fund schemes to create a segregated portfolio for debt and money market instruments in case of restructuring of debt on account of stress due to the Covid-19 pandemic.

Segregation of portfolio allows mutual funds to ‘side-pocket’ the exposure to the downgraded instrument(s) from the rest of the portfolio, which not only prevents the distressed units from affecting the liquidity of the remaining portfolio but also provides investors with an option to exit from the main portfolio while simultaneously retaining their claim on future recovery, if any, on the segregated units.

The provision for creation of segregated portfolios was first introduced by SEBI through its circular dated December 28, 2018, whereby SEBI had permitted creation of a segregated portfolio in mutual fund schemes in case of any credit event such as, downgrade of debt or money market instruments to ‘below investment’ grade, subsequent downgrade of such instruments from ‘below investment’ grade, downgrade of loan ratings, etc., by a SEBI registered credit rating agency (CRA). As per the December 2018 circular, on receipt of approval from the trustee(s) of the mutual fund, the segregated portfolio was deemed as effective from the date of the credit event, i.e. downgrade of ratings.

On August 06, 2020, the Reserve Bank of India (RBI) had extended the debt resolution facility under its Prudential Framework for Resolution of Stressed Assets, 2019 (Prudential Framework) to corporate persons under stress due to Covid-19 pandemic. Further, with a view to prevent any impact of the Covid-19 pandemic on the viability of issuers, through its circular dated August 31, 2020, SEBI had permitted CRAs to not recognise restructuring by lenders as a ‘default event’, if such restructuring is solely due to Covid-19 related stress or under the Prudential Framework. However, as per the December 2018 circular stated above, the option for creation of a segregated portfolio was available only in case of a credit event, i.e. downgrade of ratings by a CRA.

Now by way of the Circular, with a view to address this potential imbroglio, SEBI has partially modified the trigger date for creation of segregated portfolio to the date on which an asset management company receives a proposal for debt restructuring, effective till December 31, 2020. Therefore, till December 31, 2020, even if a default is not recognized by a CRA, and there is no consequent downgrade of ratings by CRA, mutual funds can create a segregated portfolio on receipt of a debt restructuring proposal under the Prudential Framework on account of Covid-19 related stress. By addressing this complication, SEBI has protected the interests of the investors in mutual fund schemes.

Further, as per the Circular, information regarding the proposal for debt restructuring is required to be immediately reported by asset management companies to valuation agencies, CRAs, debenture trustees and AMFI, and the latter shall in turn disseminate such information to its members.