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Investment Slowdown With Reference To Collapse Of Debt Mutual Funds

As the disclosure states Mutual fund investments are subjected to market risk is not just a mere caveat but a decisive factor which the investors and their advisors should consider prior to the investments

Due to the outbreak of n-Covid 2019 the Security Market in India has observed high VIX index rate, and loss of investor confidence. The FT scheme closure has been a huge setback for the Mutual Fund [specifically Debt Funds] and other retail investor, seem to lose their confidence in the market.

Fiscal and financial support for companies and employees are at the core of economic policies in response to the crisis. National and international investment policies can play an important complementary role in various ways, although not all of them can be of immediate effect. Policy measures can be tailor-made to address the specific needs of those industries particularly affected by the crisis (e.g. health, tourism, and airline, automobile).

However, the authors will be limiting the article to debt funds, they are mostly secured by debentures and other like securities which bear a fixed maturity date so the investor should wait and look forward to the winding up plan which is proposed for unit holder approval.

Introduction
The Capital market in India has a growth rate which is exponentially high in terms of resource mobilization, number of listed stocks, market capitalization, trading volumes, and investors’ base. Along with this growth, the profiles of the investors, issuers and intermediaries have changed significantly. The market has witnessed a fundamental institutional change resulting in drastic reduction in transaction costs and significant improvement in efficiency, transparency and safety.

The measures taken by SEBI such as, market determined allocation of resources, rolling settlement, sophisticated risk management and derivatives trading have greatly improved the framework and efficiency of trading and settlement, making the Indian capital market qualitatively comparable to many developed markets. The subject of Capital Market and Securities Laws is inherently complicated and is subject to constant refinement through new primary legislations, rules and regulations made there under.

Talking about the recent trends in the Indian context, we are witnessing a proactive government involvement in promoting the growth of the economy, Indian regulators proactively revamping the regulatory system in response to the changing market, healthy competition in the ecommerce industry, a boom in the startups and technology penetration by market players and so on and so forth.

The changes in recent times are very dynamic and these have led to the businesses including the financial services and capital market players to think and modify their business structures. In recent past, SEBI, Reserve Bank of India (RBI) and Government of India have been constantly coming up with various reforms / consultation papers to ensure continuous capital flow to the economy, create a strong governance structure and to ensure that the Indian capital market grows continuously to supplement the overall economic growth.

As India continues to progress, there are various challenges that the global geopolitical and financial environment poses for the future. While the world is still recovering from the aftermath of the global financial crisis of 2008-09, in a very short span of times we have witnessed a concern over the global growth resulting from the falling oil prices, slow down in Chinese economy, the exit of Britain from European Union etc. However, India continues to be a bright spot given the Government and Regulators commitment to continuously monitor risk and mitigate the impact that the global uncertainties create.

Challenges impacting the fund industry Fund industry are one of the key pioneers to supplement the capital needs for various sectors in India. SEBI in 2012 notified the SEBI (Alternative Investment Funds) Regulations, 2012, replacing the erstwhile Venture Capital Fund regulation of 1996.

Vibrant Bond Market while equity and quasi equity markets have been performing well, it is important to also develop a vibrant bond market to support the development of infrastructure and other allied sectors in the country. In the current years’ budget, the finance minister also proposed key initiatives including extending foreign investment to unlisted debt securities and pass-through securities. Going forward it will be important for the government to take initiatives which will create a deeper bond market for meeting the long term capital need. Bond market in the country is just picking up pace and still at a very nascent stage of development and a lot needs to be done towards this end.

SEBI-FMC Merger: In order to strengthen regulation of commodity forward markets and reduce wild speculations, the Forward Markets Commission has been merged with SEBI recently. Forward Contracts Regulation Act (FCRA), 1952 has been repealed and the regulation of commodity derivatives market has been shifted to the SEBI under the Securities Contracts Regulation Act (SCRA), 1956, with effect from September 2015. There are numerous benefits of the FMC merger with SEBI and this is a very positive step of moving towards an integrated platform.

Financial Inclusion is an important priority of the government. The objective of Financial Inclusion is to extend financial services to the large hitherto un-served population of the country to unlock its growth potential. Pradhan Mantri Jan-Dhan Yojana (PMJDY) envisages universal access to banking facilities with at least one basic banking account for every household, financial literacy, access to credit, insurance and pension. Under PMJDY 22.18 crore accounts have been opened with a deposit mobilization of Rs. 39,153 crore.

Other segments like the debt market, however, are almost nonexistent in India even though there has been a large volume of Government bonds traded. Banks and financial institutions have been holding a substantial part of these bonds as statutory liquidity requirement. The portfolio restrictions on financial institutions’ statutory liquidity requirement are still in place. A primary auction market for Government securities has been created and a primary dealer system was introduced in 1995.

There are six authorized primary dealers. Currently, there are 31 mutual funds, out of which 21 are in the private sector. Mutual funds were opened to the private sector in 1992. Earlier, in 1987, banks were allowed to enter this business, breaking the monopoly of the Unit Trust of India (UTI), which maintains a dominant position.

Further, which such high rates of financial inclusion Capital Markets in India have enormous growth rate. In this book I would primarily focus on leading compliance and judicial trends adopted with respect to capital markets in India.
Securities and Exchange Board of India (SEBI) is the regulatory authority for securities markets it regulates, among other entities, mutual funds, depositories, custodians and registrars and transfer agents in the country. As per SEBI (Mutual Funds) Regulations, 1996 all mutual funds operating in the market shall seek approval of the Board.[3]

Therefore under terms of Registration[4] an undertaking clause (a) of the regulation specifies that the trustees, the sponsor, the asset management company and the custodian shall comply with the provisions of SEBI (Mutual Funds) Regulations, 1996.

SEBI (Mutual Funds) Regulation, 1996 requires all Asset Management Companies and Trustees to abide by the Code of Conduct as specified in the Fifth Schedule to the Regulation. The AMFI Code[5] has been drawn up to supplement that schedule, to encourage standards higher than those prescribed by the Regulations for the benefit of investors in the mutual fund industry.

  1. Winding up a open ended fund with reference to Franklin Templeton failure
    The Securities Market, refers to the markets for those financial instruments/claims/obligations that are commonly and readily transferable by sale. The Securities Market has two inter-dependent and inseparable segments, the new issues (primary) market and the stock (secondary) market.

    The Franklin Templeton Trustee Services Private Limited (Trustee to Franklin Templeton Mutual Fund) has issued a NOTICE vide dated 23.04.2020[6] that it has decided to wind up 06 open-ended schemes of Franklin Templeton Mutual Fund pursuant to the provisions of regulation 39(2)(a) of the SEBI (Mutual Funds) Regulations, 1996.

    39. (2) A scheme of a mutual fund may be wound up, after repaying the amount due to the unit holders:
    1. on the happening of any event which, in the opinion of the trustees, requires the scheme to be wound up;

      The notice which has been served to the unit holders and the SEBI is mandatory by law as per:
      3. Where a scheme is to be wound up under sub-regulation (2), the trustees shall give notice disclosing the circumstances leading to the winding up of the scheme:
      1. to the Board; and
      2. in two daily newspapers having circulation all over India, a vernacular newspaper circulating at the place where the mutual fund is formed.

        There are typically 03 ways of winding up a Scheme under SEBI (Mutual Funds) Regulations, 1996 which are as follows:
        1. On the happening of any event which, in the opinion of the trustees, requires the scheme to be wound up; or
        2. If seventy-five per cent of the unit holders of a scheme pass a resolution that the scheme be wound up; or
        3. If the Board so directs in the interest of the unit holders.

          In order to commence any of the following a Notice has to be served in order to give effect of the same. However the Notice is only the commencement of the winding up process, the effect, procedure and manner of winding up is deem to be followed.

          Effect of winding up of a scheme is specified under Regulation 40 of SEBI (Mutual Funds) Regulations, 1996 the trustee or the asset management company as the case may be, shall:
          1. cease to carry on any business activities in respect of the scheme so wound up;
          2. cease to create or cancel units in the scheme;
          3. cease to issue or redeem units in the scheme.
             
  2. Procedure and manner for winding up
    The detailed procedure for winding up is specified under Regulation 41 of SEBI (Mutual Funds) Regulations, 1996.

    Step 1: The trustee (in the instant case Franklin Templeton Trustee Services Private Limited) shall call a meeting of the unit holders to approve by simple majority of the unit holders present and voting at the meeting resolution for authorizing the trustees or any other person to take steps for winding up of the scheme.
    Therefore only 50% of approval of unit holders is necessary. In case of close ended fund the same shall not be applicable.

    Once the approval of unit holders is received for winding up of the scheme the realization of assets and discharge of such liabilities would commence, by virtue of a waterfall mechanism.

    Step 2: The unit holders would authorize (through the resolution approved) the trustee or any other person dispose of the assets of the scheme concerned in the best interest of the unit holders of that scheme.[7]

    Step 3: The proceeds of sale realized under Step 2, shall be first utilized towards discharge of such liabilities as are due and payable under the scheme and after making appropriate provision for meeting the expenses connected with such winding up, the balance shall be paid to the unit holders in proportion to their respective interest in the assets of the scheme as on the date when the decision for winding up was taken (unit-holding as on the date of winding up notice is served).[8]

    Step 4: On the completion of the winding up, the trustee shall forward to:
    1. the Board; and
    2. the unit holders;

    A report on the winding up containing particulars such as circumstances leading to the winding up, the steps taken for disposal of assets of the fund before winding up, expenses of the fund for winding up, net assets available for distribution to the unit holders and a certificate from the auditors of the fund.

    Step 5: After the receipt of the report under Step 4 in adherence to sub-regulation (3) of regulation 41, if SEBI is satisfied that all measures for winding up of the scheme have been complied with, the scheme shall cease to exist.[9]

    Step 6: The units of a mutual fund scheme shall be delisted from a recognized stock exchange in accordance with the guidelines as may be specified by the SEBI, with immediate effect.[10]
     
  3. Plight of Investors in Franklin Templeton Scheme
    The Franklin Templeton Scheme hereinafter referred as FT has served a notice for winding up of the following schemes (all schemes were open-ended):
    1. Franklin India Low Duration Fund (No. of Segregated Portfolios – 2)
    2. Franklin India Ultra Short Bond Fund (No. of Segregated Portfolios – 1)
    3. Franklin India Short Term Income Plan (No. of Segregated Portfolios – 3)
    4. Franklin India Credit Risk Fund (No. of Segregated Portfolios – 3)
    5. Franklin India Dynamic Accrual Fund (No. of Segregated Portfolios – 3)
    6. Franklin India Income Opportunities Fund (No. of Segregated Portfolios - 2)
Now, very soon FT would be conducting the above steps in order to complete the winding up process.

However, there are some persisting question which FT would have to face for instance the Ultra Short Bond Fund which failed had 44%-45% of its lending was over 3-6 month period. Therefore, contradicting the definition of Short Duration Funds[11], the regulator has not commented upon the above contradictions yet.

Due to the outbreak of n-Covid 2019 the Security Market in India has observed high VIX index rate, and loss of investor confidence. The FT scheme closure has been a huge setback for the Mutual Fund investors and other retail investor, seem to lose their confidence in the market.

Some of the Companies to which the above funds had borrowed were Vodafone Idea Ltd, YES Bank Ltd., Infrastructure Leasing & Financial Services (IL & FS) among other companies which are facing liquidity crunch. However, since the above funds are essentially debt funds, they are mostly secured by debentures and other like securities which bear a fixed maturity date so the investor should wait and look forward to the winding up plan which is proposed for unit holder approval.

Since FT had a good record in the Debt segment of Mutual Fund and the Fund Manager Santosh Kamath aggressive and bold in the Debt Market now that the above-mentioned schemes have failed. FT will have to give a better explanation to its investors if it intends to continue its operations in India. The Regulator and the Fund House should act vehemently and resolve the redemption issue at the earliest in order to instill some confidence in the investor.

Effects On Efficient Market Hypothesis

The concept of efficient market hypothesis was first applied in U.U. Supreme Court in Basic v. Levinson[12] in which it stated that the Security Exchange Commission had to perform with a pre-conceived notion that market is efficient and independent from outside influence. The requirement of reliance in a fraud action in the securities markets is highly diluted because information is converted into price in today’s anonymous markets.[13]

This is how price sensitive information leads to an unpredicted market surge, making the trade venerable and prone to fluctuations. The trading plan of the investors and brokers are influenced when the market changes its course unprecedentedly.

Common law jurisdictions recognise two principal standards of proof: proof by a balance of probabilities for civil matters and proof beyond reasonable doubt for criminal matters. These standards communicate different notions concerning the degree of confidence that a fact finder must have in the correctness of his factual conclusions.[14]

Balance of probabilities means that a particular thing is more likely to be true than not, which is therefore based on the relative probability of a fact being true and not actual proof; in numerical terms, this translates into a probability of at least 50.1% of such fact being true.[15] Beyond reasonable doubt is a higher standard which does not require, but comes close to, actual proof with absolute certainty; in such cases, a notional numerical threshold of 90-95% may be assumed.[16]

Conclusion
Due to the outbreak of n-Covid 2019 the Security Market in India has observed high VIX index rate, and loss of investor confidence. The FT scheme closure has been a huge setback for the Mutual Fund investors and other retail investor, seem to lose their confidence in the market.

The Regulator and the Fund House should act vehemently and resolve the redemption issue at the earliest in order to instill some confidence in the investor.

End-Notes:
  1. *
  2. Regulation 3, Application for registration, SEBI (Mutual Funds) Regulations, 1996.
  3. Regulation 10, Terms and conditions of registration, SEBI (Mutual Funds) Regulations, 1996.
  4. The AMFI Code Of Ethics, https://www.amfiindia.com/Themes/Theme1/downloads/AMFI_Code_of_Ethics.pdf, last accessed on 28th March, 2020.
  5. Notice u/ Regulation 39(2)(a) https://www.franklintempletonindia.com/downloadsServlet/pdf/notice-of-winding-up-final-230420-k8lf815l
  6. Regulation 41(2)(a), Procedure and manner of winding up, SEBI (Mutual Funds) Regulations, 1996.
  7. Regulation 41(2)(b), Winding up of the scheme, SEBI (Mutual Funds) Regulations, 1996
  8. Regulation 42, Winding up of the scheme, SEBI (Mutual Funds) Regulations, 1996.
  9. Regulation 42A, Winding up of the scheme, SEBI (Mutual Funds) Regulations, 1996. (Inserted by the SEBI (Mutual Funds) (Amendment) Regulations, 2009, w.e.f. 8-4-2009)
  10. Definition of Short Duration Funds: Investment in Debt & Money Market instruments such that the Macaulay duration of the portfolio is between 3 months -6 months, SEBI Circular No.: SEBI/HO/IMD/DF3/CIR/P/2017/114, Categorization and Rationalization of Mutual Fund Schemes
  11. 108 S.Ct. 978
  12. See also Use of Modern Finance Theory in Securities Fraud Cases Involving Actively Traded Securities, 38 Bus.Law. 1, 4, n. 9 (1982)
  13. Winship, In re, 1970 SCC OnLine USSC 76 : 25 L Ed 2d 368 : 397 US 358, 370 (1970) [The term standard of proof refers to the degree of persuasion necessary for the legal burden on a person to be discharged. It represents an attempt to instruct the fact finder concerning the degree of confidence that society thinks he should have in the correctness of factual conclusions for a particular type of adjudication].
  14. H. (Minors) (Sexual Abuse: Standard of Proof), In re, 1996 AC 563 : (1996) 2 WLR 8 (HL).
  15. R. v. Starr, 2000 SCC OnLine Can SC 39 : (2000) 2 SCR 144; this higher standard owes to greater consequences following criminal offences, including loss of liberty.
Award Winning Article Is Written By:
  1. Aadarsh Kothari, Student, 4th Year, Amity Law School, Noida & AMFI registered Individual Financial Advisor ARN-149524 &
  2. Maitry Bhandari, Student, 4th Year, Amity Law School, Noida

    Awarded certificate of Excellence
    Authentication No: OT030160564629-27-1020

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