Opinion | Of pledged shares and promises to investors

MFs are not required to disclose every development. But considering fiascos such as IL&FS, a more honest approach is needed, one that dispels the myth around debt schemes being safe

There’s a standstill on corporate governance, with the story getting all too familiar. A large, well-known promoter group manages to secure funds from a mutual fund. The borrowing group has many “marquee" listed and unlisted companies whose shares it gives as pledge to the willing asset management company. In due course, problems at the group start surfacing and there’s a run on shares. The group and the mutual fund quickly get into a huddle and reach a settlement. The shares recover some ground in the next day’s trading, after the group has put out a statement talking about the faith mutual funds have in the strong balance sheet of its companies. Not a word from the mutual fund house, not a word from the regulator except, maybe, a communication from a stock exchange to the group seeking “clarifications" on media reports. It does no credit to anybody that the maximum number of AAA-rated companies is in India—this when the central government has struggled to get an upgrade of its own sovereign rating.

It’s a cause for worry for investors who look at debt funds as safe avenues to park their money. The lessons of the JP Morgan-Amtek Auto fiasco of 2015 are too recent to have been forgotten. Then, two debt schemes of the American giant’s Indian unit had seen their net asset value erode in a matter of days after a credit agency downgraded the auto component maker’s commercial paper. To be sure, mutual funds are not required to disclose every development, big or small. They do make their monthly disclosures in terms of exposure to a group, a company and the sector as a percentage of assets under management or as a percentage of their debt book. But a more honest approach is needed now, one that also dispels the myth around debt schemes being safe.

Whenever promoter groups reach an agreement with lenders, shouldn’t investors get to know what the new terms of agreement between the group and the mutual funds are since the environment is surely more adverse and the investment riskier now under a changed scenario? Investing in a paper issued by a promoter company arguably is tantamount to lending directly to the promoter, a job best suited to banks and non-banking financial companies. Why haven’t the mutual funds asked for more collateral and what are all the recourses available to them? Which are the schemes that are exposed to risky papers? Yes, mutual funds should be trusted with protecting the value of the underlying asset—a task they claim is a priority for them—but at what cost to the investor and with what surety? Is there soundness to the agreement or more hope and prayer? Shouldn’t the regulator, unarguably doing a splendid job on reducing costs, be also focused on investor safety? Is it now time to revive the market for junk securities, like in the US? These are questions that urgently beg an answer. There’s a crisis unravelling even before the dust has settled on the previous one. The victim is the hapless investor. In the wake of the IL&FS crisis, the Indian financial sector seems to be sitting on a powder keg. It needs no further heat and no “grateful to lenders" promoters.