CG @ FTMF - Debt Funds

 India’s debt fund market has been roiled in the last couple of years when two big non-banking finance companies, Infrastructure Leasing & Financial Services Ltd and Dewan Housing Finance Corp, collapsed around September 2018 and June 2019, respectively. Several debt funds that were exposed to these NBFCs had to write their investments off.

Then, in March 2020, as many as 34 debt funds saw their net asset values go down as they had exposure to Yes Bank’s debt. Of this, funds managed by Franklin Templeton Mutual Fund reportedly lost Rs 590 crore, the second-highest losses booked, after Nippon Mutual Fund’s loss of Rs 2,500 crore. 

While the corporate bond market has been suffering, prompting the Reserve Bank of India to inject more liquidity, India may not be that badly placed either. In fact, on Friday, (24 04/2020) Bloomberg reported that following the RBI’s moves, India is actually leading returns this month in Asia’s dollar bond market, with the country’s dollar bonds returning as much as 5.2% in April, as compared to the average 1.7% offered by other emerging economies in the region. 

In fact, on Monday, in a sign of hope, corporate bonds rallied and their yields plunged after the RBI announced a special open market operation auction as part of which it would buy bonds of longer durations worth Rs 10,000 crore and sell those of shorter durations of the same amount.

 

In 2015, Franklin Templeton had exposure to distressed companies like Jindal Steel & Power Ltd. In fact, Franklin Templeton was the biggest holder of JSPL’s bonds, and exited them during February and March 2016. But even back then, the fund house hadn’t taken the extreme step of shutting any of its debt funds down.  Franklin Templeton Mutual Fund (FT) announced the voluntary wind-up of six schemes as follows on 23 April 2020

Details of Schemes Wound up by FTMF as on 23 April 2021
Name of the Scheme	Scheme Characteristic (based on Macaulay duration or credit rating) as stated in the scheme information document	Macaulay Duration in Years
Franklin India Ultra Short Bond Fund	Investing in instruments with Macaulay duration between 3 months and 6 months	0.38
Franklin India Short Term Income Fund	Investing in instruments with Macaulay duration between 1 year and 3 years	2.43
Franklin India Credit Risk Fund	A bond fund focusing on AA and below rated corporate bonds (excluding AA+ rated corporate bonds).	2.36
Franklin India Low Duration Fund	Investing in instruments with Macaulay duration between 6 months and 12 months	1.17
Franklin India Dynamic Accrual Fund	Investing across duration	1.97
Franklin India Income Opportunities Fund	Investing in instruments with Macaulay duration between 3 years and 4 years	3.92

These schemes have followed a consistent investment strategy over a long period of time of investing in credits across the rating spectrum including active investments in below AAA rated securities. Such a strategy, was able to deliver meaningful outcomes for investors. However, such securities rated below AAA have been disproportionately impacted by the market dislocation. Over their long history, these schemes have been able to weather a number of market cycles and continue to provide daily liquidity. The schemes collectively held asset base of Rs 25,856 crore and unitholders of about 3 lakhs– citing continued redemption pressure and lack of liquidity in the debt markets amid the lockdown and the coronavirus pandemic. According to industry sources, Franklin Templeton MF had over Rs 3,000 crore of borrowing.

As a result, investors will no longer be allowed to make fresh purchases or sales from these funds. The systematic plans, including systematic investment plans, systematic transfer plans and systematic withdrawal plans will also be suspended.

Market participants fear that the current situation can also impact other debt schemes. Unlike banks, MFs don’t have the same manoeuvrability on their liability side. Tomorrow, investors can suddenly turn up and seek large redemption requests, which can impact debt schemes, given the current illiquid environment.

Franklin Templeton MF’s problem started when their credit call went wrong on Essel, Voda idea, ADAG group kind of exposures. Their illiquid portfolio couldn’t manage redemption pressure forcing them to borrowing. Finally they had to take the drastic step of winding down their funds. This is exactly opposite to many other fund houses. The fund house went to market recently to sell convertible debentures of a bank that was trading at 6.25%. However, the market realising the desperation of the fund house was offering to buy at 8%.

Franklin Templeton MF established in 1995 has deep retail penetration and some of the funds were popular among retirees, given the potential high yield generation.

According to industry participants, the redemption pressure has continued in April and created pain points in the Rs 22-trillion MF industry. Meanwhile, MF distributors fear investors may start to withdraw their investments in large quantum from debt schemes, following Franklin Templeton’s move. Winding up of schemes suddenly puts brakes on withdrawals for investors, until and unless the fund is able to liquidate all its holding. Some market participants felt that the cash flow for investors will be affected now adversely. With the benefit of hindsight, the situation could have been managed better, especially the concentrated investments made by Franklin Templeton MF. Market participants say the full redemption of the funds can take six-12 months. Sanjay Sapre, President at Franklin Templeton MF said the fund house will try to make payouts to investors on a staggered monthly basis.

The FY20 March redemption pressure on debt mutual funds (MFs) was the highest for the closing month of any financial year. A combination of hardening yields amid selling by foreign institutional investors and the redemption pressure from corporate treasuries seeking to conserve cash in view of the lockdown led to Rs 1.94 trillion exiting in March.

The high redemption pressure forced several debt funds to also borrow funds from banks to give exit to investors. As of March 31, 2020, Franklin Short Term Income Fund had 17.7% of assets as net liabilities. Franklin Low Duration Fund and Franklin Ultra Short Bond Fund had 12.7% and 7.1% of scheme assets, respectively, as net liabilities.

Various investors filed writ petitions in Chennai, Delhi, Ahmedabad High Courts, and in the Supreme Court against FT’s winding-up decision.

On 19 Jun 2020, the Supreme Court considered the special leave petition filed by FT and directed transfer of all pending cases to the Karnataka High Court, and gave a three-month deadline.

 

Franklin Templeton and some senior officials of the fund are being pulled up on two counts: one for money laundering and the second for favouring certain companies it had invested in and not exercising their put option when the companies went below investable grade

 

A forensic audit conducted by Choksi & Choksi found that there were 23 instances of top executives and entities withdrawing Rs 53 crore between March and April 2020, just before the winding up of the six debt schemes.

The investigation was to find out whether the fund took decisions in the best interest of the investors, whether the investments were in the spirit of rules, the rationale behind the classification of funds, failure of risk management measures, any possible collusion between the found house and bond-issuing corporate among other

If proved, it will be a clear case of insider trading, where officials of the fund knew the state of the fund and the action that the asset management company was going to take.

SEBI(Securities and Exchange Board of India) is conducting its own investigation on allegations of wrongdoing against Franklin Templeton MF and its officials.

SC is expected to pass an order in the next 7-10 days on the matter of how the winding-up regulations should be interpreted — whether trustees’ approval is enough or unitholders’ approval is a must before winding-up of mutual fund schemes.

SBI Mutual Fund will be filing its Standard Operating Procedure (SOP) in SC next week, outlining how it intends to sell the debt securities held in Franklin Templeton’s schemes.

On 3 December 2020, the Supreme court issued an interim order allowing the Trustee of Franklin Templeton to seek the consent of the unitholders for the winding up of the six schemes u/r 18(15)(c) of SEBI (Mutual Fund) Regulation 1996.

Franklin Templeton investors in these 6 debt schemes had to vote online between 26 Dec to 28 Dec 2020.  It was suggested to Vote Yes in the best interest of investors. And most investors voted Yes.

The payment to all investors whose accounts are KYC compliant with all details available will be made during the week of April 12, 2021.The amount to be paid to unitholders will be paid by extinguishing proportionate units at the net asset value dated April 9, he added.The payment will be made electronically to all eligible unitholders by SBI MF, which has been appointed as the liquidator for the schemes under winding up by the Supreme Court.In case the unitholders' bank account is not eligible for an electronic payment, a cheque or demand draft will be issued and sent to their registered address by SBI MF.

 

Securities and Exchange Board of India (SEBI) has imposed a cumulative fine of ₹15 crore on nine entities, including Franklin Templeton Trustee Services, senior official and fund managers associated with the six debt schemes wound-up by the fund house.

The monetary penalty has to be paid within 45 days from the receipt of the order, the market regulator noted in its order.

The serious lapses and violations clearly appear to be a fallout of the Franklin Templeton's "obsession" to run high yield strategies without due regard from the concomitant risk dimensions.

For a fund house which has been in this industry in India for over two and a half decades, it is surprising that its systems to monitor and manage critical risks like liquidity, credit and concentration are less than robust. The effectiveness of these systems stand compromised in the process of the noticee’s single minded pursuit of reaping high yield.

SEBI noted that the noticees cited reasons of "business judgment" to defend "questionable decisions", but these decisions which involve deployment of public funds are barely documented. The terms of investment covenants were apparently not in the interest of investors and the deficiencies in the agreements were sought to be corrected through a ‘commercial understanding’, the regulator further said.

While Franklin sold these funds to investors under different names, actually all of them were being run as credit risk funds (a high-risk investment avenue). There was non-disclosure of critical facts. And the company had breached India’s mutual fund regulations. FT did not exercise the ‘put’ option in some of the papers belonging to Reliance ADAG group companies, Essel group companies, despite the rating downgrade.

"While it is easy to shift the blame for such mishaps onto black swan events, regulatory changes, etc, the noticees needs to seriously introspect and put in place robust risk control and due diligence mechanisms, given that the rest of the industry has been able to cope with the events and survive through the crisis period of the Covid-19 pandemic, without reaching the point of winding up," SEBI said in its adjudication order.

In separate orders, SEBI imposed fines to the tune of ₹5 crore on Mywish Marketplaces, ₹25 lakh on Jayaram S Iyer, ₹45 lakh on Venkata Radhakrishnan and ₹5 lakh on Malathi Radhakrishnan. The regulator held them guilty of misusing non-public information with respect to stress in the debt schemes and redeeming their mutual fund units before they were wound up.

 

SEBI has now (Jun 08, 2021) asked the fund house to return fund management fees worth Rs 451.63 crore to investors of the six debt funds and levied 12 per cent interest fee on this amount which totals up to Rs 512.50 crore.

The amount is to be paid within 21 days and will be utilised towards repaying unitholders. SEBI further imposed a monetary fine of Rs 5 crore on the fund house.

SEBI mentioned in one of its order that Vivek Kudva, head of Asia Pacific (APAC) for Franklin Templeton, and Alok Sethi, director at Franklin Templeton Trustees, were directors on the board of Mywish Marketplaces. SEBI said (Jun 08, 2021) Vivek Kudva will be liable to pay a monetary penalty of Rs 4 crore for redemptions undertaken on his own behalf and on behalf of Vasanthi Kudva, and Roopa Kudva will be liable to pay a monetary penalty of Rs 3 crore for the redemptions from her account.

They have been penalised for redeeming their units based on non-public information regarding stress in the six wound-up debt schemes.

M/s. Mywish Marketplaces,  Jayaram S Iyer,  Venkata Radhakrishnan and  Malathi Radhakrishnan were also  held guilty of misusing non-public information with respect to stress in the debt schemes and redeeming their mutual fund units before they were wound up

Through such activities, they violated the provisions of Prohibition of Fraudulent and Unfair Trade Practices (PFUTP) norms, SBEI said.

The trustee – Franklin Templeton Trustee Services – said in a statement to Reuters (15 June 2021) that it disagreed with SEBI’s findings and intended to appeal. In a separate statement, Franklin Templeton said its employees acted “in compliance with regulations and in the best interest of unitholders”.

 

 

Questions

1. What is a Mutual Fund?

2. What is Corporate Governance?

Corporate governance is the combination of rules, processes or laws by which businesses are operated, regulated or controlled. The term encompasses the internal and external factors that affect the interests of a company’s stakeholders, including shareholders, customers, suppliers, government regulators and management. The board of directors is responsible for creating the framework for corporate governance that best aligns business conduct with objectives.

Corporate governance entails the areas of environmental awareness, ethical behavior, corporate strategy, compensation, and risk management. Specific processes that can be outlined in corporate governance include action plans, performance measurement, disclosure practices, executive compensation decisions, dividend policies, procedures for reconciling conflicts of interest and explicit or implicit contracts between the company and stakeholders.

The basic principles of corporate governance are accountability, transparency, fairness, and responsibility.

3. What is insider trading? What insider trading happened in FT MF?

Redeeming their units based on non-public information regarding stress in the six wound-up debt schemes amounted to insider trading by Vivek Kudva, head of Asia Pacific (APAC) for Franklin Templeton, and Alok Sethi, director at Franklin Templeton Trustees, who were directors on the board of Mywish Marketplaces.

M/s. Mywish Marketplaces,  Jayaram S Iyer,  Venkata Radhakrishnan and  Malathi Radhakrishnan were also  held guilty of misusing non-public information with respect to stress in the debt schemes and redeeming their mutual fund units before they were wound up

Through such activities, they violated the provisions of Prohibition of Fraudulent and Unfair Trade Practices (PFUTP) norms

3. From which regulation does the MF draw its power to wind up?

Regulation 39(2)(a) provides that a scheme of a mutual fund may be wound up on the happening of any event which, in the opinion of the Trustees, requires the scheme to be wound up. The Trustees are required to give a public notice disclosing the circumstances leading to the winding up of the scheme. As per regulation 40, on and from the date of the publication of notice as aforesaid, the trustee or the asset management company as the case may be, shall —

(a) cease to carry on any business activities in respect of the scheme so wound up;

(b) cease to create or cancel units in the scheme;

(c) cease to issue or redeem units in the scheme.

As a part of implementation of the winding-up, authorization from unitholders is needed for the Trustees or any other person to liquidate the assets of the scheme and pay the proceeds to unitholders after meeting the liabilities of the scheme. The approval of the unitholders for the same will be sought shortly via evoting.

As the schemes liquidate portfolio holdings subject to market conditions, receive coupon payments and scheduled maturities, the Trustees will start to return monies to investors at the earliest instance in compliance with regulation 41(2)(b) of SEBI (Mutual Fund) Regulations 1996.

3. When a fund house is following credit risk strategies for generating more than average returns, the market illiquidity posed by the pandemic situation cannot be blamed on the fund management. Critically examine the statement and offer your views.

4. The basic principles of corporate governance are accountability, transparency, fairness, and responsibility. How far do you think FTMF succeeded in this direction? Substantiate your answer.

References

1.  https://thewire.in/business/franklin-templeton-debt-schemes-coronavirus
2.  https://www.bemoneyaware.com/blog/franklin-templeton-debt-schemes-voting/
3.  https://www.franklintempletonindia.com/investor/market-insights/winding-up-of-6-yield-oriented-fixed-income-schemes-myths-debunked-and-faq
4. https://www.bemoneyaware.com/blog/franklin-templeton-debt-schemes-voting/
5.  https://www.business-standard.com/article/companies/franklin-templeton-unitholders-to-get-rs-2-962-cr-in-second-tranche-121041100299_1.html
6.  https://in.news.yahoo.com/sebi-bans-franklin-templeton-mf-
7.   e_referrer_sig=AQAAAFLevwGh362ZdflG0k3pFDQ4bJfHQvIxizLOVu1nv92pipd_6P_IGGLeq1sUf-6upQzNK4mBL7l8UqGFEsFLS0aMz22L7hA7-rhAiu5zL1fN_Ua2qBc-heHd8xu3oDFR249j3mZQcGFYvQ17JOP3N3IH_BhNdjCK7nHIB-ChFTmB
8.  https://www.livemint.com/mutual-fund/mf-news/sebi-imposes-rs-15-cr-fine-on-franklin-templeton-8-others-over-wound-up-schemes-11623676795027.html
9.  https://thewire.in/business/sebi-fines-franklin-templeton-indias-trustee-and-ceo-for-violating-rule