When a credit event (downgrade to below investment grade or actual default of unrated debt) occurs and Trustees approve side-pocketing, how is a Segregated Portfolio created and operated?

[ A ]The bad debt is written off entirely by charging 100% of the loss to newly entering unitholders.

[ B ]The affected debt security is moved to a segregated portfolio, equal units are allotted to existing unitholders, separate daily NAVs are published, and units are listed on a stock exchange within 10 working days to facilitate liquidity.[ CORRECT ]

[ C ]All existing unitholders are forced to pay cash to the defaulted issuer within 48 hours.

[ D ]The main scheme is terminated immediately and all investor folios are permanently deleted.

Takeaway

Option B is correct: The affected debt security is moved to a segregated portfolio, equal units are allotted to existing unitholders, separate daily NAVs are published, and units are listed on a stock exchange within 10 working days to facilitate liquidity.

Derivation

Under SEBI's side-pocketing framework: Upon a credit event or actual default, the AMC (with Trustee approval) segregates the distressed debt instrument into a separate 'Segregated Portfolio'. All existing unitholders as of the credit event date receive an identical number of units in the segregated portfolio as held in the main portfolio. Separate NAVs are declared daily for both portfolios. While subscriptions and direct redemptions are barred in the segregated portfolio, the AMC must list the units on a recognized stock exchange within 10 working days to provide an exit route. This tests side-pocketing mechanics. The common trap is assuming new subscribers participate in the bad debt.

Why the others fail

A — The bad debt is written off entirely by charging 100% of the loss to newly entering unitholders.

Newly subscribing investors receive units only in the clean main portfolio and are completely insulated from past segregated debt.

C — All existing unitholders are forced to pay cash to the defaulted issuer within 48 hours.

Unitholders have limited liability to their invested capital and can never be forced to make cash contributions to defaulted issuers.

D — The main scheme is terminated immediately and all investor folios are permanently deleted.

The main scheme continues normal daily operations with liquid assets, while only the distressed paper is isolated in the side pocket.