Passive breach

Some breaches of an investment limit happen because a portfolio manager buys too much. A passive breach is different — the manager buys nothing new, but a limit is crossed anyway because prices moved. If a related-party holding was 8% of the portfolio and within the client's consented limit, and the rest of the portfolio then falls in value while that holding does not, the same holding can become 12% of a now-smaller portfolio without a single new trade.

XXI-A's own use of the term is narrow and specific: it appears in the rule requiring a client's prior consent before a portfolio manager invests in the securities of its own related parties or associates.

Chapter 12, drawing on Regulation 22(1A) of the Portfolio Managers Regulations, requires a portfolio manager to obtain a client's prior consent — positive consent or recorded dissent — before investing in securities of its own related parties or associates, with the client free to set a limit on such investment. Having taken that consent, the portfolio manager must then maintain records of three things: instances of the passive breach of investment limits (if any), the steps taken to rectify a passive breach, and any waiver the client has given regarding rebalancing when a passive breach occurs.

The structure makes clear that a passive breach is expected to happen occasionally in ordinary market conditions, and is not itself a violation — what the regulation polices is what the portfolio manager does about it afterwards: record it, take steps to rectify it, or obtain the client's waiver if the client agrees not to force an immediate rebalance.

A client of portfolio manager Vantage PMS Ltd has consented to related-party securities — bonds issued by Vantage's own group NBFC — making up at most 10% of the portfolio. At the last review, the group NBFC bonds were worth Rs 9,00,000 in a Rs 90,00,000 portfolio, exactly the 10% ceiling, and Vantage made no further purchase of them.

Over the following quarter, the rest of the portfolio — largely equity — falls by 15% while the bond holding's value is unchanged at Rs 9,00,000. The portfolio is now worth roughly Rs 79,20,000, and the unchanged Rs 9,00,000 bond position is now:

Rs 9,00,000 ÷ Rs 79,20,000 ≈ 11.4% of the portfolio

The 10% limit has been crossed without Vantage buying a single additional bond — a passive breach caused entirely by the fall in the rest of the portfolio's value. Vantage records the breach, and either sells down the bond position to rectify it or obtains the client's written waiver against an immediate forced sale, and keeps both the record of the breach and whichever route it took on file.

Chapter 12 (Regulatory, Governance and Ethical Aspects of Portfolio Managers) sets this out under the related-party consent requirement. The examinable point is the distinction between an active breach (the manager buys past the limit) and a passive breach (the limit is crossed by market movement with no new purchase) — and the fact that the regulation requires record-keeping and rectification or waiver for the passive kind, rather than treating it as automatically prohibited.

• A passive breach involves no new purchase. If the manager bought more of the related-party security to push it past the limit, that is an active breach, not a passive one.
• A passive breach is not automatically a violation — the regulation's response is to require records, rectification steps, or a client waiver, not to ban the situation outright.
• The client can waive rebalancing, but the waiver itself must be recorded — silence is not a waiver.
• This provision is about related-party or associate securities specifically, tied to the prior-consent requirement under Regulation 22(1A) — it is not a general limit-breach rule for every kind of investment restriction in the portfolio.