When humans can have health & life insurance covers to protect them against unforeseen and unexpected risks in life, Backstop Facility is a risk protection mechanism for debt funds.
What is a Backstop facility?
Backstop facility, also called as Rescue Facility, is like an insurance for a debt fund which is undergoing a stress.
As an example, if the fund is invested in very long-term securities (like long term debt funds), and there is a sudden demand for liquidation, a fund may not be able to fulfil the same, though every mutual fund is legally obliged to do so.
Remember the Franklin Templeton mutual fund fiasco of 2020? In such a rare case, the backstop facility comes in handy.
Why is there a need for a rescue fund?
In the Franklin Templeton episode of 2020, six of its schemes had to be wound down after a severe market dislocation dried up liquidity in their underlying holding. This prevented the fund house from meeting a wave of redemption requests (because of Covid scenario) without undertaking a fire sale.
SEBI has come up with a super Fund called as the Corporate Debt Market Development Fund. this will act as a last resort buyer in such situations. It will buy illiquid security from the affected funds in a market dislocation, providing them with liquidity. It will keep those securities with itself and sell them at maturity.
Who is paying for this protection?
There are no free lunches in the world.
- The participating debt schemes and AMCs will pay to avail of this facility. All debt schemes barring Overnight and Gilt funds will contribute point 0.25% of their assets under management to this fund.
- Every 6 months, the debt funds will make incremental contributions if there is a rise in AUM.
- Against these contributions, the participating AMCs and debt funds will get units in the superfund.
- The AMC making the contribution cannot take its money back if any of it debt schemes AUM falls.
Does the Corporate Debt Market Development Fund have an expense ratio?
Yes, like any other fund, the Corporate Debt Market Development Fund (CDMDF) will also have an expense ratio.
As per SEBI's framework, the fees and expense ratio of the fund will be as follows:
During Normal times: 0.15% + tax of the Portfolio Value is charged on a daily pro-rata basis.
During Market stress: 0.20% + tax of the Portfolio Value charged on a daily pro-rata basis.
Disclosure of NAV of Corporate Debt Market Development Fund
Like any other fund, CDMDF should disclose its NAV. The NAV will be disclosed by 9:30 PM on all business days on the website of its Investment Manager and AMFI. And for times when CDMDF would have exposure to corporate debt, such NAV would be required to be disclosed by 11 PM on all business days.
Where does CDMDF invest its money?
CDMDF will invest in short duration government securities bills among others. In a severe market dislocation as defined by SEBI and affected that came may approach the CDMDF to purchase the troubled security.
Why are Overnight and Gilt Funds not included?
Overnight funds are excluded because they are anyway very liquid. Gilt Funds are on the other extreme end of the spectrum where the tenure is so long that it may not be possible for these funds to be rescued efficiently. But in any case, Gilt funds are 100% secure by nature.
How much funds are guaranteed for protection?
The proposed CDMDF will have an initial corpus of Rs 3,000 crore contributed by mutual funds.
The government has approved a 10-time leverage of the fund (Additional corpus), thus CDMDF may raise funds up to Rs 30,000 crore.
Who guarantees and manages this fund?
CDMDF shall be launched as a closed-ended scheme with an initial tenure of 15 years from the date of its initial closing. It will be sponsored and managed by SBI Funds Management Ltd., the Asset Management Company of SBI Mutual Fund (SBI AMC), which is a 'Deemed Government Company' under the Companies Act, 2013, as it is owned and controlled directly or indirectly by the Government.
The CDMDF would be required to comply with the Guarantee Scheme for Corporate Debt (GSCD) as notified by the Ministry of Finance. The Trust/Fund to manage the scheme is called the Guarantee Fund for Corporate Debt (GFCD).
GFCD is a Trust Fund formed by the Department of Economic Affairs (DEA), Ministry of Finance, Government of India and shall be managed by National Credit Guarantee Trustee Company Ltd. (NCGTC), a wholly owned company of the Department of Financial Services (DFS), Ministry of Finance, Government of India.
Hence, there is a 100% guarantee against the debt raised by CDMDF. The guarantee shall cover debt raised, along with interest accrued and other bank charges thereon, and shall not exceed Rs 30,000 crore.
How will investors benefit from this Backstop Facility?
In times of extreme stress or credit risk, the Backstop Facility in the form of CDMDF would ensure debt mutual funds do not have to sell their quality underlying portfolio to meet redemption pressures or due to rating downgrades and address the liquidity needs. For investors, it shall nearly eliminate the risk of fund houses abruptly shutting their debt-oriented mutual fund schemes.
But other than that, all other risks associated with the debt funds are not going to be covered, and hence the investor should still make an informed judgment about the debt funds to buy after consulting with their financial advisor.
Regards
Manoj Arora
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