HFDC AMC was already in the news for all the wrong reasons. It had frozen the FMP redemptions on some of its FMPs that had invested heavily in bonds issued by a subsidiary of the Essel Group. It turned out that this was nothing but mutual funds doing promoter funding in the guise of bond investments were backed by promoter shares in Zee Entertainment and that too with limited coverage. Add to that; the HDFC AMC also entered into a standstill agreement with the promoters of the Zee group saying that they would not sell the pledged shares of Zee Entertainment till September by which time Subhash Chandra was supposed to sell part of his stake to a global partner and raise the required money. The truth was that they had inadequate coverage and the sharp fall in the Zee price meant that these funds would be caught on the wrong foot with huge losses.
Even as the funds were being pulled up by the regulator, SEBI, and the media for being callous with public money, HDFC AMC came up with a unique arrangement of guaranteeing part of the FMP investor money with the funds supplied by the AMC. HDFC Asset Management Co. Ltd’s decision to provide ‘liquidity’ to its investors in some fixed maturity plans (FMP) may have been welcomed by the fund holders but it did take the shareholders by surprise and also raised some serious issues of corporate governance. After all, how could the group forsake the resources of a listed company with public shareholders for the risks taken by the fund managers?
Is it one time or could it repeat?
That was the million dollar question. Shareholders were not comfortable being invested in an AMC where such shocks to fund holders would be funded by the shareholders. This wasn’t how it was supposed to be. The cost of bearing market risks was meant to be at the door of mutual fund investors. After all, mutual funds are risky investments and such things are adequately disclosed in the offer document. Also investors in debt funds should have understood that a credit risk fund is not a G-Sec fund or a blue chip bond fund and must have been prepared for this elevated level of risk.
How exactly will the intervention be structured?
The arrangement will work something like this! HDFC AMC will have an arrangement wherein it will provide liquidity of about Rs.500 crore specifically against the non-convertible debentures (NCDs) issued by firms promoted by the Essel group on its books. This liquidity, although only partial, will be used to fulfil obligations to the unit holders of the FMPs that have instrument in these Essel instruments and who want to exit the fund. For those who stay on in the fund, these funds will not be required and the estimate is that there may not be too much demand as the exiting fund holders will have to do so at a discount. Now we have the big catch in this arrangement. Since, HDFC and other mutual funds have a standstill arrangement with the Essel group until September 2019, the value realized from the NCDs will be known only then and that is when the real extent of loss will be known. At this point, the redemption will be done based on a notional basis.
What exactly happens at the end of the standstill agreement? If there is a shortfall on that day in the redemption, the cost will be borne by shareholders of HDFC AMC rather than the FMP unit holders. Let us remember that the NCDs are backed by collateral of Zee shares. If the Essel Group is unable to redeem the debentures by September, the AMC will have to offload the stock in the market. Normally, large stock sales in the market tend to have a high impact cost during the offloading process. It could also mean that HDFC AMC recovers far less than the Rs.500 crore it has provided in liquidity. Any under-recovery will directly impact the bottom line of the AMC and its stock price.
Actually, HDFC may have done the right thing
While there is a lot of debate about the rights of the shareholders versus the unit holders, there is an important issue most of us are forgetting here. The biggest asset for the HDFC group is its brand. For a group that has a market capitalization of $150 billion, setting aside $70 million for protecting the brand is actually a very small investment. That is exactly what HDFC has done. In this case, the larger end does justify the means. It is more important that the trust and the brand value implicit in the HDFC name are protected. Everything becomes secondary and trust is the last thing that the group can afford to lose.