SEBI approval for side-pocketing in mutual funds spells good news for old and new investors

Mutual fund houses in India are still licking their wounds from what has turned out to be in hindsight their embarrassing investments in Infrastructure Leasing & Financial Services Ltd which had been amiss in meeting its commitments to creditors and lenders after running up a whopping Rs 91,000 crore liabilities through a myriad of labyrinthine subsidiaries and associates. The mutual fund industry’s ineptitude has been compounded by the negligence of credit rating agencies which had blithely awarded top ratings for the IL&FS group papers, obviously doing shoddy research themselves. In 2016 – post-the JP Morgan Asset Management ’s investments in Amtek Auto going sour and the fund house trying to resort to side-pocketing in vain at that time – the Association of Mutual Funds of India had approached SEBI to set rules for creation of side-pockets when faced with an adverse credit event. However, in a board meet held on 12 December 2018 in Mumbai, SEBI, in a change of heart and perception, accepted the recommendations to allow side-pocketing made by the SEBI’s mutual fund advisory committee. While mutual fund houses have by and large welcomed this thaw in SEBI’s perception, there are critics who wonder if this would encourage brinkmanship on the part of fund houses, secure in the knowledge that should something go wrong, they can always side-pocket the bad debt investments and ring fence the newcomers from their downside risks.