Introduction of a Backstop Facility for Specified Debt Funds during Market Dislocations

Securities and Exchange Board of India (“SEBI”) vide its press release dated March 29, 2023 (“Press Release”) approved the amendments to SEBI (Alternative Investment Funds) Regulations, 2012 for setting up of Corporate Debt Market Development Fund (“CDMDF” or “Fund”) in the form of an Alternative Investment Funds (“AIF”) to act as a backstop facility.

A backstop facility in stock market means a financial agreement or arrangement that creates a supplementary source of funds if the original source of funds fails to satisfy the essential demands thereby being a last-resort support. CDMDF will function as a backstop facility for the acquisition of investment grade corporate debt instruments during times of stress, instilling confidence among corporate bond market participants and generally improving secondary market liquidity. SEBI on June 15, 2023 notified the SEBI (Alternative Investment Funds) (Second Amendment) Regulations 2023 wherein certain amendments were made along with the introduction of Chapter III-C (Corporate Debt Market Development Fund) allowing for the creation of an initial corpus of CDMDF through contribution by specified debt mutual fund schemes and asset management companies. Further, on June 26, 2023, SEBI vide SEBI (Mutual Funds) (Amendments) Regulations, 2023 has allowed mutual funds and asset management companies of the mutual funds to invest in the units of the Fund.

CDMDF shall be formed in the form of a Trust, registered as an AIF in accordance with the provisions of Chapter II of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, and shall be a closed-ended fund with a lifespan of fifteen (15) years from the date of its initial closure, with an option to extend the tenure with SEBI's prior permission. The instrument of trust must take the form of a deed and must be registered per the provisions of the Indian Registration Act of 1908.

CDMDF shall designate a trustee company, with the Board of Directors (“BODs”) of such company and the manager of CDMDF shall be chosen with the prior approval of SEBI. Two-thirds of the trustee company's BODs must be independent and not associated with the sponsor or management. No one shall be appointed as a director of the trustee company without the prior approval of SEBI, either initially or at any time subsequently. The trustee company of the Fund shall not engage in any activity other than acting as a trustee of the Fund, except with the prior written consent of the BODs.

The initial corpus of the Fund is being reported to be Rs 3,000 crore to act as a backstop facility for purchase of investment grade corporate debt securities during times of stress and the Fund may borrow funds up to ten times of its corpus. The units shall be offered to the Asset Management Companies registered with SEBI and specified debt-oriented schemes of mutual funds in accordance with the provisions of SEBI (Mutual Funds) Regulations, 1996. However, credit lines from lenders could also be availed by the Fund based on a guarantee provided by National Credit Guarantee Trust Company.

The Fund shall invest in liquid and low-risk debt instruments and undertake any other activity related to corporate debt market. However, during the period of market dislocation, the Fund shall purchase corporate debt securities from the specified debt-oriented schemes of mutual funds which meet the following criteria:

i. Corporate debt securities shall be listed and have an investment grade rating;

ii. the residual maturity of such securities shall exceed five years on the date of purchase;

iii. securities where there is no material possibility of default or adverse credit news or views; and

iv. securities are of the companies incorporated in India.

The Fund shall hold the eligible securities till the maturity or sell the same in the secondary market upon reversal of market dislocation in the manner specified by SEBI.

In reference to the ‘market dislocation’ SEBI shall decide the trigger of market dislocation and its reversal based on the parameters as specified by SEBI.

The units of the Fund are prohibited to be listed on any recognised stock exchange.

Audit Committee: Audit Committee shall be constituted for review of compliance with the provisions of placement memorandum along with other responsibilities as may be specified by SEBI.

Governance Committee: The manager of the Fund shall appoint a governance committee comprising of corporate market experts including academicians, fund managers or chief investment officers, risk management professionals and independent market experts. The committee along with the manager and trustee company shall be responsible to approve the policies of the Fund.

The Governance Committee shall have oversight on management of asset liability mismatches during times of market dislocation.

Compliance Officer: The manager of the Fund shall appoint a compliance officer who shall be responsible for monitoring compliance with the applicable law and shall independently report to SEBI any non-compliance as soon as possible but not later than seven (7) days from the date of observing such non-compliance.

Market dislocations are difficult to define and calculate. It is often described as the circumstances or occurrence in which financial markets stop to price assets accurately in absolute and relative terms when functioning under stressful situations. When such situations develop, the whole banking, financial services, and insurance industry experience liquidity strain. With these amendments by SEBI, there will be confidence among the corporate bond market participants and the secondary market liquidity will also be enhanced while also discouraging consumers from selling securities during a market dislocation event. However, there is no agreed-upon definition of market dislocation. The parameters of a market dislocation may differ from person to person which leaves a wide discretion on SEBI. Since the Fund is a one-of-a-kind fund that the government will establish to provide liquidity in the debt market during times of market disruption, its basic idea will not significantly disrupt the AIF industry. The industry reactions are yet to be observed, which will bring out the acceptance of the Fund by the industry.

Kawaljeet Kaur is a Senior Associate and Rachit Munjal is an Associate at SNG & Partners.