The century scored by the regulator in issuing the much-awaited order in the case of Franklin Templeton Mutual Fund (MF) has hogged the headlines in the media and the order that the asset management company (AMC) shall return the fees collected from 4 June 2018 in all the affected schemes to the investors is being seen as a major victory for the investors.
The 100- page order of the Securities and Exchange Board of India (SEBI) has not set the Arabian Sea on fire in any manner. Rather than being viewed as an indictment of the AMC, the order is actually a litany of the failure of the regulator in stepping in early and asserting its importance as an agency that does not wait for the outside world to wake it up from its slumber, but that it has an effective alarm clock that blares loud enough when there is danger.
Most of the issues considered in the order, in my humble opinion, neither needed a forensic investigation nor the benefit of hindsight to identify. It was obvious and stares anyone in the face like an erupting volcano!
It is not my intent to analyse the case, issue-wise, as there are better-equipped experts like compliance specialists, who will examine the applicability of the SEBI circulars purportedly violated and the transgression of the terms of the schemes which were shared with the investors.
Franklin Templeton is not any unique case. It is like many non-banking finance companies (NBFC) collapses that have happened over time and are continuing to happen. The schemes were taking credit calls to maximise return and it is trite that high returns in debt is correlated to high and disproportionate risk. Most of these schemes were returning eye-popping returns compared to the peer group since 2016 and 2017, may be even earlier but my cut off is when I started tracking these schemes.
The papers they were investing in were in no way hidden; it was quite clear the money was not going into top companies in the BSE50, but many that were like special purpose vehicles (SPVs) set up to address specific credit situations like an asset reconstruction company (ARC), or real estate fund. There could have been no ambiguity in the mind of anybody with basic market knowledge that most of the investments were in the nature of structured debt and not standard issues where large number of market participants invest.
What is it that the forensic report and the investigation undertaken by SEBI has discovered anew? It would have been equally explicit from the monthly data that the fund house provides that many of the investments were common across multiple schemes. Equally, a little effort, SEBI could have discovered that the investments formed a lion’s share of the borrowings of the investee companies.
Most of these investments would have been issued under private placement of debt, that are supposedly listed in the wholesale debt market and, hence, all issue details are filed with SEBI!
Two of the most critical discoveries of the 100-page order are that the schemes together constituted bulk investors in many cases. Moreover, despite differences in the credit risk characteristics of the six schemes, many investors were, indeed common. Both these facts could have been noted long back from the data available with SEBI.
The next major issue is the calculation of the (Macaulay) duration of the papers and their fitment into schemes which were essentially shorter term in nature. Here again, I would assume that in the years since the inception of these schemes there would have been many inspections by SEBI and if these issues were not investigated at that time, it is a shame!
The fund house has taken calls on not pressing for repayment when the borrower was distressed. SEBI has viewed this poorly and made it a big issue in the order. I would hold my judgement.
But this was also widely reported in the media as these cases of credit defaults are noticed immediately thanks to the vigilance of various reporting agencies and invariably the press caries the mutual funds schemes that have exposure to these companies.
It may be a specious argument to say that rescheduling of terms does not get reported as a credit event for rating purposes. These ought not to deter an agency like SEBI from monitoring the happenings in the market, as it knows that the mutual fund industry has big stakes in the credit market and lakhs of small investors are indirectly exposed to the risk.
If SEBI is operating on the basis that it will act only when asked to by a court of law, or when the muck hits the ceiling, it has no right to exist at all.
In respect of the six problem schemes, the inflows had reduced right from about August 2019 and the outflow had increased. These are typical tell-tale sign of impending trouble. Borrowings started in a big way around this time and even SEBI was approached for a higher limit. Yet, the regulator was deep in slumber.
When the Vodafone and Essel group defaults happened, some of the portals that rate MF schemes woke up for the first time and both ultra-short and low duration schemes that had enjoyed uninterrupted five-star rating got revised. Still, SEBI felt there was no alarm and did not bother to react.
The fund house, Franklin Templeton, had imposed restrictions on online withdrawals some time perhaps in March or early April 2020. Though the fund house has denied this in writing, it was a fact. The software, if audited, would certainly have a trail of how it was tampered with.
Even this did not attract SEBI’s attention. It was perhaps easier to wake up Kumbakarna because there was a set protocol as one can notice by reading the Ramayana and wake up, he did, once those were followed!
SEBI has an alarm clock that snoozes without the button being operated and most pitiably, is not even sensitive to the aroma of Kumbakonam degree coffee as well!
While the disgorging of the management fee is being played up in the media as a major development in regulatory reprisal, I would like to see the day when the salary of the SEBI officials is withheld for their incompetence!!
The order has come in a record time if compared to the one that came some time back after a gap of two decades in the case of a famous tycoon!
The Supreme Court should not think its role ends when the schemes are wound up and the investors are paid. This is a perfect opportunity to bring SEBI to account so that it does not end up like Reserve Bank of India (RBI), which is beyond redemption now!
If this does not happen in a hurry, frankly the investors have only the temples to trust!!
(The author is a CA and CS and retired as a partner at EY, Chennai heading tax and regulatory advice.)