Mutual Funds Regulations- SEBI Proposes Amendments

Introduction

Among Indians, mutual funds¹ remain the preferred investment when it comes to investing and developing investment portfolio. Assets Under Management (AUM) of Indian Mutual Fund Industry as on April 30, 2024 stood at ₹ 57,25,898 crore. The AUM of the Indian MF Industry has grown from ₹9.45 trillion as on April 30, 2014 to ₹57.26 trillion as on April 30, 2024 more than 6 fold increase in a span of 10 years.²

The market regulator of India every now and again contrives to enhance transparency, protect investor's interest and promote the healthy functioning of the mutual funds industry. The Securities and Exchange Board of India (SEBI) recently approved revisions to the SEBI (Mutual Funds) Regulations, 1996, which aims to improve the regulatory environment for Asset Management Companies (AMCs)³. Following the market regulator's recent observations, these amendments require AMCs to implement institutional safeguards to combat potential market abuse, including front running.

These amendments, far from being a mere amendment, are designed to be a full-fledged revolution, aiming to reshape the sector.

Mutual Fund regulations- Proposed Amendment- 2024

1. Establishing a formalized institutional framework for recognition and prevention of possible market abuse, such as front-running and fraudulent securities transactions-
   • A structured institutional mechanism is proposed for asset management companies (AMCs) to proactively identify and prevent market abuse, including front-running and fraudulent transactions in securities.
   • This mechanism includes enhanced surveillance systems, internal control procedures, and escalation processes to detect and address specific types of misconduct.
   • The proposal suggests amending the MF Regulations to require AMCs to establish this institutional mechanism and to include a definition of 'market abuse' to provide clarity.
2. Improving AMC management's accountability and responsibility for the Institutional Mechanism-
   • Enhancing responsibility and accountability of AMC management.
   • Active involvement and oversight of senior management is crucial for effective institutional mechanism.
   • Making senior management accountable for institutional mechanism implementation fosters compliance and accountability. Proposed institutional mechanism aims to assign specific responsibility to CEO/MD and Chief Compliance Officer of AMCs.
   • Proposal suggests amending MF Regulations to hold CEO/MD and Chief Compliance Officer responsible for institutional mechanism implementation.
3. Whistle Blower Policy-
   • Whistle blower policy implementation within AMCs as it enables reporting of unethical practices and potential market abuse by the employees and stakeholders.
   • Promotes confidentiality and protection for whistle blowers.
   • Facilitates detection of issues and corrective actions.
   • Proposal to amend MF Regulations for whistle blower policy implementation.
4. Relaxation on Fund Managers and Dealers (FMD's) obligation to record all communications-
   • The current code of conduct for FMDs outlines specific requirements for communication, disclosures, and transparency. FMDs are required to communicate during market hours through recorded modes and channels. They must communicate in an unambiguous, transparent, accurate, and professional manner. They may share general market views without disclosing confidential information. They are prohibited from disseminating false or misleading information and from disclosing material non-public information. The SEBI Master Circular on Mutual Funds also mandates that all dealer conversations must be through dedicated recorded telephone lines.However, industry participants have requested relaxation of the requirement for recording communication during market hours due to challenges in interactions with third parties during investor meets and conferences.The SEBI last year on June 27, 2023 released a distinct amendment⁴ focusing on the eligibility criteria for sponsors under mutual funds. The principal component have been discussed below.

Key highlights of the Previous Amendment- 2023:

1. Strengthening the main criteria-
   
   The amendment enhanced the existing eligibility conditions for mutual fund sponsors, which require sponsors to have been in the "business of financial services" ("Original Criteria"), and requires the sponsor to have;
   • minimum average net profit of INR 10 crore over the previous five years;
   • a net profit in all of the prior five years (rather than the previous condition of profit in three of the five years);
   • positive "liquid net worth" (cash, money market instruments, T-Bills, and G-Secs) that exceeds the sponsor's intended capital contribution.

2. Alternative requirements-
   • The Amendment also provided other eligibility requirements ("Alternate Criteria"), which permits non-financial service organizations and "a private equity fund, a pooled investment vehicle, or a pooled investment fund" to become sponsors, subject to
   • Infusion of INR 150 crore into the asset management company ("AMC");
   • an ownership equal to the initial capitalisation of INR 150 crore to be locked in for five years;
   • Appointing experienced top management officials with at least 30 years of combined experience; and
   • In the case of an acquisition of an existing AMC, maintain liquid net worth equal to the incremental capitalisation to increase the AMC's net worth to INR 150 crore.

3. 'Existing' sponsors to "disassociate" from an AMC-

The Amendment offered a framework for 'existing' sponsors to voluntarily "disassociate" from an AMC, based on the parameters established by SEBI, and subject to following parameters,

• AMC has a diverse shareholding (no single stakeholder owns more than 10%); and
• AMC's board of directors is two-third independent directors.

Conclusion

The mutual funds market is experiencing growth, driven by increased invention and innovation in financial technology. The market regulator's decision to bring amendment in framework for mutual funds shall create significant impact in the mutual fund industry. The regulation is vital for maintaining investor confidence, ensuring market integrity, protecting investors and maintaining financial stability. SEBI's regulatory framework plays a crucial role in overseeing and guiding the mutual fund industry, ensuring that it operates in a fair, transparent and efficient manner as well. By adhering to these regulations, mutual funds can continue to be a valuable investment vehicle for investors in India.

Aishwarya Rajput, Assessment Intern at S.S. Rana & Co. has assisted in the research of this article.

Footnotes

1 A mutual fund is a collection of assets managed by a professional fund manager. It is a trust that collects money from a group of individuals with similar financial goals and invests it in stocks, bonds, money market instruments, and/or other securities. SEBI controls mutual funds under the SEBI (Mutual Funds) Regulations 1996.

2 Available at https://www.amfiindia.com/indian-mutual#:~:text=Indian%20Mutual%20Fund%20Industry's%20Average,at%20%E2%82%B9%2057%2C01%2C359%20crore .

3 Available at https://www.sebi.gov.in/sebi_data/meetingfiles/may-2024/1715144023897_1.pdf

4 Available at https://www.sebi.gov.in/legal/regulations/jun-2023/securities-and-exchange-board-of-india-mutual-funds-amendment-regulations-2023_73224.html

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