Franklin Templeton Mutual Fund: SEBI Should Smell the Coffee and Disable Snooze Button!
Ranganathan V 08 June 2021
The century scored by the regulator in issuing the much-awaited order in the case of Franklin Templeton Mutual Fund (MF) has hogged the headlines in the media and the order that the asset management company (AMC) shall return the fees collected from 4 June 2018 in all the affected schemes to the investors is being seen as a major victory for the investors.
 
The 100- page order of the Securities and Exchange Board of India (SEBI) has not set the Arabian Sea on fire in any manner. Rather than being viewed as an indictment of the AMC, the order is actually a litany of the failure of the regulator in stepping in early and asserting its importance as an agency that does not wait for the outside world to wake it up from its slumber, but that it has an effective alarm clock that blares loud enough when there is danger. 
 
Most of the issues considered in the order, in my humble opinion, neither needed a forensic investigation nor the benefit of hindsight to identify. It was obvious and stares anyone in the face like an erupting volcano!
 
It is not my intent to analyse the case, issue-wise, as there are better-equipped experts like compliance specialists, who will examine the applicability of the SEBI circulars purportedly violated and the transgression of the terms of the schemes which were shared with the investors.
 
Franklin Templeton is not any unique case. It is like many non-banking finance companies (NBFC) collapses that have happened over time and are continuing to happen. The schemes were taking credit calls to maximise return and it is trite that high returns in debt is correlated to high and disproportionate risk. Most of these schemes were returning eye-popping returns compared to the peer group since 2016 and 2017, may be even earlier but my cut off is when I started tracking these schemes.
 
The papers they were investing in were in no way hidden; it was quite clear the money was not going into top companies in the BSE50, but many that were like special purpose vehicles (SPVs) set up to address specific credit situations like an asset reconstruction company (ARC), or real estate fund. There could have been no ambiguity in the mind of anybody with basic market knowledge that most of the investments were in the nature of structured debt and not standard issues where large number of market participants invest. 
 
What is it that the forensic report and the investigation undertaken by SEBI has discovered anew? It would have been equally explicit from the monthly data that the fund house provides that many of the investments were common across multiple schemes. Equally, a little effort, SEBI could have discovered that the investments formed a lion’s share of the borrowings of the investee companies.
 
Most of these investments would have been issued under private placement of debt, that are supposedly listed in the wholesale debt market and, hence, all issue details are filed with SEBI!
 
Two of the most critical discoveries of the 100-page order are that the schemes together constituted bulk investors in many cases. Moreover, despite differences in the credit risk characteristics of the six schemes, many investors were, indeed common. Both these facts could have been noted long back from the data available with SEBI.
 
The next major issue is the calculation of the (Macaulay) duration of the papers and their fitment into schemes which were essentially shorter term in nature. Here again, I would assume that in the years since the inception of these schemes there would have been many inspections by SEBI and if these issues were not investigated at that time, it is a shame!
 
The fund house has taken calls on not pressing for repayment when the borrower was distressed. SEBI has viewed this poorly and made it a big issue in the order. I would hold my judgement.  
 
But this was also widely reported in the media as these cases of credit defaults are noticed immediately thanks to the vigilance of various reporting agencies and invariably the press caries the mutual funds schemes that have exposure to these companies. 
 
It may be a specious argument to say that rescheduling of terms does not get reported as a credit event for rating purposes. These ought not to deter an agency like SEBI from monitoring the happenings in the market, as it knows that the mutual fund industry has big stakes in the credit market and lakhs of small investors are indirectly exposed to the risk. 
 
If SEBI is operating on the basis that it will act only when asked to by a court of law, or when the muck hits the ceiling, it has no right to exist at all. 
 
In respect of the six problem schemes, the inflows had reduced right from about August 2019 and the outflow had increased. These are typical tell-tale sign of impending trouble. Borrowings started in a big way around this time and even SEBI was approached for a higher limit. Yet, the regulator was deep in slumber. 
 
When the Vodafone and Essel group defaults happened, some of the portals that rate MF schemes woke up for the first time and both ultra-short and low duration schemes that had enjoyed uninterrupted five-star rating got revised. Still, SEBI felt there was no alarm and did not bother to react.
 
The fund house, Franklin Templeton, had imposed restrictions on online withdrawals some time perhaps in March or early April 2020. Though the fund house has denied this in writing, it was a fact. The software, if audited, would certainly have a trail of how it was tampered with. 
 
Even this did not attract SEBI’s attention. It was perhaps easier to wake up Kumbakarna because there was a set protocol as one can notice by reading the Ramayana and wake up, he did, once those were followed! 
 
SEBI has an alarm clock that snoozes without the button being operated and most pitiably, is not even sensitive to the aroma of Kumbakonam degree coffee as well!
 
While the disgorging of the management fee is being played up in the media as a major development in regulatory reprisal, I would like to see the day when the salary of the SEBI officials is withheld for their incompetence!! 
 
The order has come in a record time if compared to the one that came some time back after a gap of two decades in the case of a famous tycoon!
 
The Supreme Court should not think its role ends when the schemes are wound up and the investors are paid. This is a perfect opportunity to bring SEBI to account so that it does not end up like Reserve Bank of India (RBI), which is beyond redemption now!
 
If this does not happen in a hurry, frankly the investors have only the temples to trust!!
 
(The author is a CA and CS and retired as a partner at EY, Chennai heading tax and regulatory advice.
Comments
sundarbtw
1 day ago
Corporate bond markets in India exist for the benefit of lenders and not at borrowers. It is astonishing to note that year on year blue-chip PSUs are paying high rate of interest for these bonds. It is naive to believe that these PSUs have not understood the interest rate cycle. They have deliberately issued bonds without call option and year on year paying very high interest rates when they are making huge cash surpluses...
sundarbtw
1 day ago
Corporate bond markets in India exist for the benefit of lenders and not at borrowers. It is astonishing to note that year on year blue-chip PSUs are paying high rate of interest for these bonds. It is naive to believe that these PSUs have not understood the interest rate cycle. They have deliberately issued bonds without call option and year on year paying very high interest rates when they are making huge cash surpluses...
kuuladi
2 days ago
great comments on the way the babus at SEBI work. many issues that plague the indian bond markets are as a result of lack of expertise in the regulators or lack of intent in genuine reforms by the regulator. the corporate bond market is shallow in india. beyond a few large groups most of the bonds are illiquid. on one side the policy says that the corporates should raise money from the markets for their long term requirements and on the other side they dont create enough liquidity or market for such bonds. this systemic risk hasnt been addressed for many years/decades. banks keep very high margins while lending to mid and small sized companies which makes the cost of borrowing a big burden for these companies. capital expenditure cannot happen with rates being so high. banks cannot fund for M&A and NBFC rates are even higher for companies to borrow. where do they go? they go to the mutual funds. the joke is that those very bond issues are approved by the regulators and rating given by the rating agencies. by definition AA is a very good rating. it is very tough to get such rating. but those bonds are illiquid many times. the ratings have lost sanctity many times. i hope we learn from such experiences. but our regulator is a sleeping elephant.
regulators with a vision should have taken steps prior to an incident by learning from the past experiences or from others. the US & EU did not have a frozen bond market due to covid as they announced unlimited bond purchases. the govt here also did that but that was about a month or two late. killing the bond holders of Yes bank created a sense of panic in the market. a rare case where equity holders didnt lose their value while bond holders got wiped out. such ad hoc measures result in destruction of investor faith in the markets. the regulator is making one a scape goat but if they were to conduct a similar audit of all funds in the market, many such skeletons will stumble. people with great expertise in the markets go on to become the heads of regulators in USA while we have our typical babus with little or no expertise on markets who head these key positions. we have to learn from our mistakes, pay competitive compensation and get resources with relevant knowledge and expertise to head these positions. ad hoc nature of circulars and rules will not give any confidence to the market. a predictable regulator with logical rules which are in sync with global best practices is the need of the hour. issuing circular after circular shows only incompetence in drafting regulations. a regulation should be clear and devoid of all ambiguities. sadly the system we are stuck in gives very little importance to such things. the more the ambiguities the more the chances for interpretation for the babus to wield their powers. an opinion or two by the likes of moneylife will not make a difference to these guys. kudos to mr ranganathan for writing on the main problem.
pprk2586
2 days ago
The risk disclaimer should be put at tha top of application in bold letters
kumar.gangadharan
3 days ago
In addition to the usual disclaimer, "MF investments are subject to market risks etc"..we need to add "subject to top-management risks" as well
deoa1948
4 days ago
The unethical role of Kudva family is shocking !
People graduate from top IIT & IIM in the country getting top jobs do not show even little honesty , while enjoying the best.
cjninan
4 days ago
We all know what SEBI did, what is more important is what were those website like morning star and value research doing. They were giving stars after stars and give those gyan emails every single day. One smart twit even said that if you get higher return then be prepared for losses as well.
Even today, these websites talk as if nothing has happened, the minimum they could have done is review these funds and advise small retail investors.
parimalshah1
4 days ago
AS usual the SEBI as a regulator, like so many other regulatory agencies, are sleeping on the wheel all the while. They wake up only when there is a bump or collision depending on the gravity of the accident and take their own sweet time to wake up from the slumber. Then take so called punitive action which is usually miniscule in comparison to the crime perpetrated on the victims. This will not improve unless the regulator/s are held accountable by the judiciary. Government is not bothered because the money lost is of citizens who are not in a position to take on the large institutions.
pandeysdk
5 days ago
superb views sir. SEBI has framed very flimsy guidelines due to which many AMCs were able to run funds with impunity. franklin has just followed those guidelines and SEBI is now imposing fines to gain popularity and to cover up their incompetence. i wont be surprised if franklin gets away with lot of charges in SAT because of these rules framed by SEBI. even today, many medium term funds in the market have over 50% exposure to non AAA papers. since SEBI is a regulator they can impose whatever fines or penalties to be seen as saviors while they are the actual culprits. kudos to you for pointing out the lacunae in SEBI.
axpert1
5 days ago
They have first recovered their borrowing costs and other financial expenses from realisation. Why they should be allowed ?
nnkamani
5 days ago
Beagle Boys in action

Govt Agency FT and others-They all appear to work in cohesion.
The victims are those who trusted FT and invested their money on Big Talks of their superior ability to find high yielding papers compared to other MF’s.
Penalty a trivial Rs5Cr for 25000Cr agony.
Haven’t seen such daylight robbery happening in the 21st century.
bhattacharjee.madhumita
5 days ago
prolific! Awesome articulation
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