Lending against shares: MFs bite more than what they can chew
It is now up to the fund houses to ensure that the Essel Group’s promoters repay their debts with the capital market regulator opting to remain a spectator, for now.
The ball is back in mutual funds’ court. It is now up to the fund houses to ensure that the Essel Group’s promoters repay their debts with the capital market regulator opting to remain a spectator, for now. Fund officials holding Essel Group’s debt securities had approached Securities and Exchange Board of India for its view on giving cash-strapped promoters time till end September to repay their money. Sebi — known for being pedantic at times — put the onus on the mutual funds to do what is best for its unitholders, opting to steer clear of a potential regulatory minefield.
Industry officials think Sebi played it smartly because an approval or rejection of the so-called agreement between funds and the promoters of Zee and Dish TV would have severe consequences.
This arrangement gives Essel Group promoters six months by which they should sell a stake in Zee and repay the money. This pact was on the heels of a crash in shares of Zee and Dish TV.
Promoters had borrowed money from funds with shares as the collateral. A drop in share values required Zee’s promoters led by Subhash Chandra to bring in extra shares or cash as a top-up to make up for the shortfall in collateral.
With Chandra admitting that he was short of funds or shares to top up the collateral, there was a risk of lenders such as mutual funds and NBFCs dumping the pledged shares if the share value fell further.
While the unprecedented pact between lenders and Chandra averted a fall in the group’s share prices, nervous mutual funds might have felt the regulator’s blessings would be an insurance cover. Sebi probably looked at it differently. If it gave its nod for the deal between mutual funds and Zee promoters, that would set a precedent, encouraging reckless lending and many such agreements in the future. In case Sebi rejected the proposal outright, it would have resulted in an immediate crash in Zee’s share price, resulting in ratings downgrades of such papers and losses to investors holding these securities. It would heighten the crisis of confidence in the debt market, which was started by the IL&FS default. Here, the regulator too would have had to shoulder the blame in an adverse event. So, choosing to be onlooker made sense.
A notable aspect of the event is that the contours of deal involving promoters of a bluechip company like Zee and lenders is out in the open. The credit for this goes to Chandra who openly acknowledged that he was short of money to repay lenders though critics say he had few other options. In many such cases in the past, mutual funds have chosen to sweep potential defaults under the carpet. Asset managers would roll over the loans from one month to the other without the unitholders in schemes holding such papers being even aware of it, taking advantage of the fact that portfolios of the debt securities need to be disclosed only at the end of every month. In the case of Zee, at least there is a deadline.
Mutual fund officials believe Sebi is unlikely to let go of this an opportunity to tighten norms especially on lending against shares by mutual funds. There is a need for exposure restrictions to such lending, according to them, mainly because mutual funds use unitholders’ money to lend unlike banks and NBFCs, which do not have to report their daily NAVs. Another key concern over such lending to promoter entities is the quality of the collateral (shares) and their liquidity. Mutual funds accept shares as collateral and credit rating agencies give them top notch rating going by the market value of the company. But, the extent of liquidity in these shares is rarely taken into account while valuing them. For instance, Zee’s market capitalization before the crash was over Rs40,000 crore but the daily traded volumes were a fraction. Even if funds holding large quantities of Zee shares as collateral wanted to exit, it would not have been possible withput causing mayhem.
In theory, listed shares are the most liquid collateral but without adequate liquidity, they are riskier guarantees for lenders especially mutual funds. Irrespective of how the Zee event unfolds, the regulator is likely to bring in more checks and balances for mutual funds’ lending against shares.