Loan against shares under regulators lens

Mumbai: Financial market regulators are examining ‘the loan against share’ issue in the aftermath of the recent FMP fiasco.

According to sources, RBI, Sebi and Irdai are looking into exposure of NBFCs, insurance companies and mutual funds to the toxic structured debt papers backed by promoter holding. It is estimated that exposures to the tune of Rs 50,000 crore are at risk.

Last week, Kotak Mahindra Mutual Fund declared that investors of its fixed maturity plans FMP Series 127 and 183 would not be able to redeem their entire amount because of its exposure to the debt papers of Essel Group. This would also apply to other FMPs coming up for redemption in the near future. Similarly, HDFC Mutual Fund also announced plans to roll over one of its FMPs due for redemption next week. HDFC FMP 1168D MF Scheme maturing on April 15 gets extended by 380 days.

It has come as a rude shock for investors who considered FMPs to be a suitable alternative to bank fixed deposits.

Based on the portfolios of December 2018, the overall mutual fund exposure to the Essel Group was Rs 8,000 crore, of which, Rs 1,670 crore was held in close-ended funds like FMPs. Fund houses that have FMP exposure to Essel Group include Aditya Birla Sun Life (Rs 77 crore), DHFL Pramerica (Rs 7 crore), HDFC MF (Rs 902 crore), ICICI Prudential (Rs 121 crore), Kotak MF (Rs 381 crore) and Reliance (Rs 185 crore).

“Given that the decision to delay the repayment of the Essel bonds has been agreed upon, asset managers should proactively inform investors well in advance about part redemptions in FMPs that hold these bonds. This will help manage investor expectations as well as help investors plan their liquidity. Going ahead, it would be prudent for asset managers to relook at how such ‘loan against shares’ transactions are structured, especially by placing covenants around how much can a promoter pledge. Otherwise, in cases of over-pledged promoters, such collateral remains as paper collateral which cannot be enforced effectively when required,” said Morning-star in a recent report.

However, according to experts, the problem is much larger and runs deeper than what news reports have suggested about Zee, Yes Bank and lL&FS groups.

Debt papers of these groups had AAA rating before default. So debt papers from other which have not yet defaulted should not be construed sound and safe, say experts.

Market speculation is that besides mutual funds, even insurance companies too have significant exposure in structured debt/CLOs, or collateralised loan obligations. Together these two categories of institutions have Rs 3.5 lakh crore investments—MFs about Rs 2.25-2.5 lakh crore and insurance about Rs 1 lakh crore—in such CLOs across schemes. By the market estimates, the amount defaulted in the current round may be about Rs 50,000 crore.

Experts said the layering is so well-crafted that the three players—MFs, corporates, rating agencies—have been able to exploit the situation to their advantage.

MFs have gone beyond their mandate and invested in a risky instrument—loan against share—that is not commensurate with the risk profile of FMP investors, who are typically ultra conservative.