Gating

An open-ended scheme promises investors they can redeem on any business day. Usually it keeps that promise by selling securities. But in a genuine market-wide crisis — when almost nothing can be sold at a fair price — meeting a flood of redemptions would mean dumping assets at distressed prices, and the investors who stay would bear the damage.

Gating, or restriction on redemption, lets a fund pause part of the outflow in exactly that situation. The workbook is emphatic about the philosophy: it should apply during excess redemption requests arising from overall market crisis situations, not in exceptional circumstances of entity-specific situations. The illiquidity must affect almost all securities in the market, not one issuer's paper.

It is not a tool to manage a scheme's own liquidity, and it cannot be used to cover up illiquidity in a particular security bought through a poor investment decision. For that problem — one bad bond — SEBI provides a different tool: the segregated portfolio.

A restriction may be imposed only for a systemic crisis or event that severely constricts market liquidity or the efficient functioning of markets, such as:

The safeguards:

• Maximum period: not exceeding 10 working days in any 90-day period.
• Approval: specific approval of the Board of the AMC and the Trustees, with SEBI informed immediately.
• Redemption requests up to Rs 2 lakh are not restricted at all.
• For requests above Rs 2 lakh, the first Rs 2 lakh is redeemed without restriction; only the amount above it is subject to the restriction.
• The possibility of restriction, and its time limit, must be disclosed prominently in scheme-related documents.

Why it matters is shown by the workbook's credit-event arithmetic. A Rs 10,000 crore scheme holds 8 per cent — Rs 800 crore — in debenture M, which is downgraded. Investors redeem 20 per cent (Rs 2,000 crore); nobody will buy M, so the manager sells the good paper. The corpus falls to Rs 8,000 crore and exposure to M rises to 10 per cent. If the corpus halves again, exposure doubles to 20 per cent. Every exit makes the remaining investors' position worse.

Markets are closed for part of a week by an unexpected emergency, and liquidity in almost all debt securities dries up. The AMC board and trustees approve a restriction on redemptions in a debt scheme, and SEBI is informed. Three redemption requests arrive:

The small investor is entirely unaffected. Each larger request still gets its first Rs 2 lakh. The request amounts are illustrative; the Rs 2 lakh rule is the workbook's.

Now count the time. If the restriction begins on a Monday, it can run for at most 10 working days, and across any rolling 90-day window the total restricted time cannot exceed 10 working days. The fund cannot, for instance, gate for 10 working days, lift it for a week, and gate again.

Contrast a different case: the same scheme holds one downgraded bond and faces heavy redemptions, but the rest of the market is trading normally. Gating is not allowed — this is an issuer-specific problem. The route is to create a segregated portfolio, with trustee approval.

Chapter 10 (Risk, Return and Performance of Funds), section 10.8, introduces credit events with the debenture M example; section 10.8.1 sets out the gating conditions, the 10-working-days-in-90 limit and the Rs 2 lakh carve-out, followed by segregated portfolios in 10.8.2. Expect recall of the time limit and the Rs 2 lakh rule, a scenario on how much of a large request is paid, and a question distinguishing situations that permit gating from issuer-specific ones.

• 10 working days in any 90-day period — not 10 calendar days, and not 90 working days.
• Up to Rs 2 lakh is never restricted, and the first Rs 2 lakh of any larger request is always paid.
• Market-wide only. Illiquidity in a specific security, or a poor investment decision, does not qualify.
• Not a scheme liquidity-management tool. AMCs must have their own liquidity systems.
• Approval: AMC board and trustees; SEBI is informed immediately — SEBI does not pre-approve it in the workbook's description.
• Gating is not side-pocketing. Gating restricts redemptions across the scheme temporarily; a segregated portfolio ring-fences a credit-affected security.