SEBI considers ‘backstop facility’ to ease stress on debt funds
India’s market regulator is considering setting up a “backstop facility” to support mutual funds’ purchases of relatively illiquid investment-grade corporate bonds to ease stress on debt systems.
“The backstop facility would be an entity that can trade relatively illiquid investment-grade corporate bonds and is readily available during times of stress to purchase such bonds from market participants in the secondary market,” said Ajay Tyagi, chairman of Securities and Exchange Board of India: “Obviously, a broad general guiding principle for any such entity to be established, market participants should be involved and the issue of moral hazard should be satisfactorily addressed.”
Earlier this year, mutual funds saw significant redemption pressures across several debt-related schemes, forcing them to sell more liquid securities. The Franklin Temple Mutual Fund wound down six of its debt programs citing a lack of liquidity. This caused portfolios to become even more illiquid, Tyagi said, speaking at the annual general meeting of the Association of Mutual Funds in India.
A committee with representatives from the mutual fund industry has already met to discuss setting up such a facility, which would function somewhat like a primary dealer, an executive at an asset management firm told BloombergQuint on condition of anonymity as the matter is still under consideration. The person explained how it would work.
- Mutual funds would need to invest capital to set up such an entity.
- The company would then be able to buy illiquid mutual fund assets in exchange for government bonds.
- The size of the company and its available pool of capital would have to be large to deal with an event like the Franklin-Templeton problem.
- Significant investments would therefore be required.