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Market regulator Sebi probes Franklin Templeton India unit

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Sebi’s probe seeks to understand the fund house’s commitment to adequate risk managementFranklin’s parent company based in the US has initiated an inquiry into the reasons leading to the Indian arm’s drastic decision

MUMBAI : India’s markets regulator will investigate whether Franklin Templeton’s local unit had violated rules or acted in the best interest of its investors, following the collapse of six of the asset manager’s debt funds, two people with direct knowledge of the developments said.

Franklin Templeton India’s US parent has also initiated an inquiry.

The Securities and Exchange Board of India (Sebi) will probe whether the asset manager had misrepresented the risk involved in investing in these funds by inaccurately classifying them as ‘income’ funds, committed a violation of the model code of conduct, and whether the fund’s investments met fiduciary requirements.

“It is to ascertain whether there was a failure of risk management,” said one of the two people mentioned above. “The queries from Sebi are on the portfolio of these six schemes, rationale for choosing these papers, extent of bank borrowing, and how liquid the underlying bonds are,” according to this person.

Typically, in such instances, Sebi audits the investment rationale and minutes of meetings of the investment committee for the past five years, the person said.

The schemes allegedly did not follow Sebi’s scheme classification mandate. Credit risk funds must invest at least 65% of their holdings in securities rated below AA+, according to Sebi norms. Other types of debt schemes, including income funds, are meant to invest in higher-rated bonds.

The asset manager’s parent is also looking into the reasons leading to the drastic action, said the second person mentioned above.

The parent’s inquiries revolve around the impact of the decision on their brand, while Sebi’s probe seeks to understand the fund house’s commitment to adequate risk management, portfolio diversification, credit research and whether the funds violated Sebi’s fund categorization norms, the person said.

“The Franklin inquiry involves questions to the Indian team about prudential steps taken by the asset manager while launching and running the schemes and whether the fund house had kept aside adequate surplus cash to meet redemption stress,” the person said.

In an emailed statement, Franklin Templeton said that the decision to shut the schemes was imperative to protect the existing investors. “We believe that taking this extraordinarily difficult decision during this unprecedented time was necessary and the right thing to do. Quick and decisive action was imperative to protect the existing investors in these funds,”said a US-based spokesperson for Franklin Templeton.

The six schemes shut were called yield-oriented credit managed scheme by Franklin Templeton and income funds by industry body Association of Mutual Funds in India. Five of these schemes have invested in bonds with ratings ranging from 88% to 100% below AA+.

Specific queries sent to Franklin Templeton on the Sebi probe were not answered.

Franklin Templeton is the sole lender to 26 out of 88 entities in its debt schemes’ portfolio, according to a report by B&K Securities.

“Questions of inadequate risk management are bound to arise. Sebi as an institution heavily promotes mutual fund investments more than any other form of investments. If a mutual fund like Franklin Templeton takes the winding down route, there is something we may be missing here. Therefore, it is both an enforcement as well as policy issue,” said Sumit Agrawal, managing partner, Regstreet Law, and a former Sebi officer.