Sebi issues show cause notices to HDFC, Kotak mutual fund over FMP woes

Mumbai: The Securities and Exchange Board of India (Sebi) has initiated adjudication against HDFC Asset Management Company Ltd or HDFC AMC and Kotak Mutual Fund over the so-called Fixed Maturity Plan (FMP) woes. The FMPs of these asset management companies were impacted due to their investment in Essel Group papers forcing Kotak to hold back redemptions and HDFC to rollover the entire FMP.

HDFC in disclosure to stock exchanges said that it has received two show cause notices from Sebi on 10 May for violation of mutual fund regulations.

A spokesperson for Kotak did not reply to an email seeking comments.

As per two people directly aware of the developments, Sebi’s show cause notices to the two fund houses have cited violation of mutual fund regulations and investor protection.

“The maturity of the under lying papers of Essel group companies was more than the maturity of the FMP which is a violation of Sebi rules,” said the first of the two people.

Two Essel Group companies, Konti Infrapower and Multiventures Pvt. Ltd and Edisons Utility Works Pvt. Ltd, failed to repay in full the investment of the FMPs.

The AMCs in January, which had exposure to Essel group papers, decided to not sell promoters’ pledged shares to recover their dues. Reliance mutual fund was one of the few AMCs which did not agree to this so-called standstill agreement and sold the Essel papers on 8 May.

To honour this agreement Kotak AMC decided to hold part of the payments that were due to mature on 8 April.

HDFC AMC on the other hand, ahead of the maturity date of 15 April, decided to roll over the FMPs that held the Essel paper by more than a year.

Due to holding back payments the maturity of the underlying paper invariably became higher than the maturity of the debt mutual fund. This is against the Sebi norms governing mutual funds.

“In case of Kotak the maturity of underlying paper has exceeded the debt fund by more than 30 days. In case of HDFC the maturity of underlying paper exceeded the debt fund by two days,” said the second of the two people quoted above.

“Kotak also failed to take consent from investors before deciding to hold back part redemption,” he added.

This is a fallout of fund managers investing in papers which are backed by pledged shares, popularly known as Loan against Shares (LAS). The fund industry as of January had an exposure of 51,000 crore to such papers.

“This is a significant policy issue where Sebi will have to relook at mutual fund regulations. The foundation, for which investors invest in FMPs on one hand and the risks fund managers take by investing in assets which turn a bad investment in hindsight, will require balancing. Within Sebi limits concentration of portfolio in such assets is a business decision and tweaking of such limits with disclosures may be something Sebi may look at from policy view. The idea is to protect the sanctity of product and promise to unit holders.” said Sumit Agrawal of Regstreet Law Advisors & ex-Sebi official.