Franklin Templeton six-scheme winding-up (April 2020)

The Franklin Templeton six-scheme winding-up of 23 April 2020 was the abrupt and unilateral closure of six fixed-income open-end mutual fund schemes by Franklin Templeton Asset Management (India) Private Limited, trapping approximately Rs 25,000 crore (then approximately USD 3.3 billion) of investor assets at the outset. The closure, announced without prior public notice or investor consent, constituted the largest simultaneous wind-up of open-end mutual fund schemes in Indian history. It set off protracted legal proceedings before the Supreme Court of India, a landmark enforcement action by the Securities and Exchange Board of India, and fundamental regulatory changes that reshaped the liquidity and governance framework applicable to all debt mutual funds in the country.

Background: Franklin Templeton’s India debt strategy

Franklin Templeton Mutual Fund entered the Indian market in 1996 and built a substantial franchise in fixed-income schemes. By the mid-2010s, the AMC had positioned several of its debt funds as differentiated yield-seeking vehicles that invested in lower-rated, illiquid, and structured credit instruments, including securitised debt, non-convertible debentures of housing finance companies, mortgage-backed securities, and bonds of real estate and infrastructure companies. These schemes included credit risk funds, ultra-short bond funds, and medium-duration bond funds.

The investment strategy reflected a broader industry trend of debt funds moving down the credit quality spectrum to generate higher yields at a time when top-rated corporate bonds offered compressed spreads. Franklin Templeton’s India fixed-income team, led by Santosh Kamath as Chief Investment Officer for Fixed Income, built an exceptionally concentrated position in the lower-rated segment. By 2019, several schemes had exposures to stressed entities including Vodafone Idea, Essel Group, DHFL, Yes Bank, and various structured obligations of developers and NBFCs.

Context: the 2018–2020 credit stress cycle

The Indian credit market entered a multi-year stress cycle following the IL&FS default in September 2018, which froze interbank lending to NBFCs and triggered a broad reassessment of structured credit risk. Subsequent defaults by DHFL, the Essel Group promoters’ pledge-related sales, and the writedown of Yes Bank AT1 bonds in March 2020 progressively impaired the portfolios of credit-oriented debt funds across the industry. Franklin Templeton’s six schemes, with their concentrated low-rated exposures, were disproportionately affected.

Simultaneously, the onset of the COVID-19 pandemic in March 2020 caused unprecedented volatility in domestic financial markets. Corporate bond liquidity evaporated as mutual funds across the industry faced surge redemptions, the Reserve Bank of India announced emergency liquidity measures, and several NBFC borrowers requested moratoriums on their debt obligations. Franklin Templeton’s schemes faced a particular liquidity squeeze: the instruments they held were largely illiquid in secondary markets, and the surge in redemption requests could not be met without distressed sales that would have crystallised losses and further depleted scheme assets to the detriment of remaining unitholders.

The winding-up announcement: 23 April 2020

At approximately 7:30 PM on 23 April 2020, Franklin Templeton Mutual Fund published a press statement and scheme-specific notices announcing the immediate winding-up of the following six schemes:

1. Franklin India Ultra Short Bond Fund
2. Franklin India Low Duration Fund
3. Franklin India Short Term Income Plan
4. Franklin India Credit Risk Fund
5. Franklin India Dynamic Accrual Fund
6. Franklin India Income Opportunities Fund

The combined AUM at the time of winding-up was approximately Rs 25,215 crore. Franklin Templeton cited SEBI Regulation 39(2)(a), which permits trustees to wind up a scheme if they consider it in the interest of unitholders, as the legal basis for the unilateral closure without a unitholder vote. No prior public disclosure, regulatory consultation, or investor notification had preceded the announcement.

The winding-up suspended all redemptions, switches, and new investments immediately. Investors in these six schemes had no ability to exit their positions regardless of holding size or urgency of financial need. The announcement caused immediate distress among retail and high-net-worth investors who had placed funds in these schemes expecting the liquidity associated with open-end mutual funds.

Franklin Templeton stated that the portfolios contained a high proportion of illiquid instruments, that redemption pressures had been acute, and that an orderly winding-up with managed realisation of portfolio assets was more likely to preserve investor value than continued forced selling in illiquid secondary markets.

Legal proceedings

Investor petitions and High Court challenge

Within days of the announcement, investor groups and industry bodies filed petitions in several High Courts. The Karnataka High Court, being the jurisdiction for Franklin Templeton’s registered office in Bengaluru, became the primary forum. Petitioners argued that the unilateral winding-up without unitholder consent was illegal, that trustees had not followed due process, and that SEBI had failed in its supervisory duty by not intervening to prevent or scrutinise the closure.

Supreme Court intervention

On 12 October 2020, the Supreme Court of India stayed the execution of the winding-up and directed that the matter be adjudicated by the Apex Court directly, consolidating cases from multiple High Courts. The Supreme Court appointed SBI Mutual Fund as the administrator for asset realisation on an interim basis and directed that no amounts realised from portfolio securities be distributed to investors without its approval.

In an important procedural ruling on 9 February 2021, the Supreme Court held that a unitholder vote was mandatory before a scheme could be wound up, rejecting Franklin Templeton’s contention that trustees could proceed unilaterally under Regulation 39(2)(a). The Court ordered an e-voting process to be conducted for unitholders of all six schemes to ratify or reject the winding-up.

E-voting concluded in June 2021, and unitholders of all six schemes voted in favour of winding-up by large majorities, indicating that, while the procedural defect was real, the substantive decision to wind-up commanded investor consent once they had been given the facts.

The Supreme Court approved the first distribution of realised proceeds from three schemes in October 2021. Subsequent tranches were distributed as portfolio assets were liquidated over the following two years.

SEBI enforcement action

In June 2021, SEBI issued a detailed Show Cause Notice to Franklin Templeton AMC, its trustees, and key personnel. On 7 June 2022, SEBI passed a comprehensive enforcement order running to over 140 pages.

Key findings of the SEBI order

SEBI’s order made several significant findings:

Breach of investment concentration norms: The six schemes had violated SEBI’s single-issuer exposure limits and sector concentration rules by building excessive positions in illiquid structured instruments and related-party conduits.

Misrepresentation in scheme documents: Franklin Templeton’s scheme information documents had described the funds as offering appropriate liquidity for open-end vehicles. SEBI found that the actual portfolio composition was inconsistent with these representations.

Unlawful segregation attempt: In March 2020, in the weeks before the winding-up, Franklin Templeton had attempted to side-pocket Vodafone Idea exposures in several schemes. SEBI found procedural irregularities in this segregation.

Management fee collection during stress: SEBI found that Franklin Templeton had continued to collect investment management fees during the period when liquidity was impaired and investors could not exit, constituting a conflict of interest.

Penalties and bars

SEBI’s order of June 2022 directed:

• Franklin Templeton AMC to disgorge approximately Rs 512 crore of investment management fees earned from the six schemes during the period January 2018 to April 2020, with interest.
• Santosh Kamath (CIO Fixed Income) to be barred from associating with any SEBI-registered intermediary for two years.
• Other senior fund managers associated with the schemes received individual restrictions of varying durations.
• Franklin Templeton trustees were reprimanded and directed to strengthen oversight frameworks.

Franklin Templeton appealed SEBI’s order to the Securities Appellate Tribunal (SAT), which partially modified certain individual penalties while largely upholding the substantive findings and the disgorgement order.

Investor repayments

By the end of 2023, Franklin Templeton had returned approximately Rs 27,000 crore to unitholders of the six schemes, exceeding the Rs 25,215 crore AUM at the time of winding-up. The excess arose because portfolio assets were realised at values that, taken in aggregate, exceeded the prices implied by the crisis-period NAVs at wind-up date, benefiting from improved credit market conditions in 2021–2022. Interest income accrued during the winding-up period also contributed to the surplus.

The relatively complete recovery stood in contrast to initial investor fears of large capital losses and moderated some of the reputational damage to the AMC, though distribution had taken over three years and involved significant legal costs.

Regulatory aftermath

SEBI circular on winding-up procedures (October 2020)

In October 2020, SEBI issued Circular No. SEBI/HO/IMD/DF2/CIR/P/2020/203 amending the SEBI (Mutual Funds) Regulations, 1996 to require that the winding-up of a scheme be subject to a simple majority vote by value of outstanding units. This effectively codified the Supreme Court’s procedural ruling and prevented any future unilateral trustee winding-up without unitholder approval.

Liquidity stress testing mandate

SEBI mandated that AMCs conduct monthly liquidity stress tests on all open-end debt schemes and publish the results in a standardised format. The stress tests require AMCs to disclose the number of days required to liquidate 50 percent and 75 percent of the portfolio under normal and stressed market conditions. This disclosure requirement was directly motivated by the opacity of Franklin Templeton’s illiquid portfolio.

Limits on credit risk concentration

SEBI tightened single-issuer and sector concentration limits for open-end debt schemes and introduced mandatory minimum percentages of investments in high-quality liquid instruments. Credit risk funds were specifically restricted in their ability to hold unrated or sub-investment-grade instruments beyond defined caps.

Risk-o-meter overhaul

SEBI overhauled its risk labelling framework for mutual funds, introducing a seven-level risk-o-meter replacing the earlier five-level system. The risk-o-meter for each scheme must be published with each NAV statement, making scheme-level liquidity and credit risk more visible to retail investors. The Association of Mutual Funds in India operationalised the new framework from 1 January 2021.

Impact on the NAV cut-off reform of 2021

The Franklin Templeton episode contributed to SEBI’s motivation to reform the NAV cut-off mechanism for debt funds, implemented from 1 February 2021, ensuring that large purchases of debt scheme units were credited only after actual funds were received, preventing the exploitation of timing arbitrage that had distorted flows into debt schemes.

Lasting industry significance

The Franklin Templeton winding-up was a watershed event for Indian fixed-income mutual funds. It dispelled the assumption, widely held by retail investors, that open-end mutual funds are inherently liquid at all times and that fund managers would not or could not gate redemptions. The episode prompted a reassessment of credit risk fund strategies across the industry, with many AMCs reducing or eliminating positions in sub-investment-grade instruments and structured credit.

The legal precedent established by the Supreme Court on mandatory unitholder voting for winding-up significantly strengthened investor rights and constrained trustee discretion. SEBI’s disgorgement order against the AMC established a precedent that fee income earned during periods of portfolio mismanagement and liquidity impairment could be clawed back, a meaningful deterrent against structurally aggressive credit strategies in open-end vehicles.

Franklin Templeton’s India business suffered lasting reputational damage. The AMC, which had managed approximately Rs 1.25 lakh crore AUM across all schemes at its peak in 2018, saw assets decline sharply as investors withdrew from both the affected and unaffected schemes. By 2023, Franklin Templeton’s Indian AUM had contracted substantially, and the AMC had strategically repositioned away from its credit-risk differentiation and toward more conventional fixed-income mandates.

Key dates

See also

• Mutual fund industry in India
• Securities and Exchange Board of India
• IL&FS default impact on debt funds (2018)
• DHFL default impact on credit-risk funds
• Yes Bank AT1 bond writedown impact on mutual funds
• Side-pocketing introduction (2018)
• NAV cut-off reform (1 February 2021)
• Association of Mutual Funds in India