I have a piece with Raghuvamsi Meka in yesterday's Financial Express which is linked here (paywalled currently) and the full article can be accessed below:
The mutual fund industry grew by leaps and bounds in the last decade. To continue this momentum, innovation, competition and consolidation has to form the bedrock of the industry. Recognising this, in April 2022, SEBI has set up a working group to review the role and eligibility of a sponsor of mutual fund. The terms of reference of the Working Group set up under the chairmanship of Mr. A Balasubramanian (MD/CEO of Aditya Birla Sun Life AMC) are to recommend an alternative set of eligibility criteria for entities to act as sponsor, to review the existing eligibility requirements for being a sponsor, to recommend mechanisms for addressing conflict of interest that may arise if pooled investment vehicles/private equity act as sponsor, and to examine the need for sponsor to dilute its stake in asset management company. SEBI allowing private equity players to own mutual funds will be a huge disruption in this space. It was anticipated last September that SEBI may ease mutual fund ownership rules to allow private equity players to act as sponsors. However, before approving changes to the MF Regulations, SEBI has decided to set up a working group to review the role and eligibility of a sponsor. SEBI isn’t the first regulator to be thinking along these lines. In December 2017, the Insurance Regulatory and Development Authority of India issued the IRDAI (Investment by Private Equity Funds in Indian Insurance Companies) Guidelines, 2017. These guidelines allow private equity funds to invest in insurance companies in the capacity of a promoter.
Private equity funds have played an active role in the development of mutual fund markets around the world. They have routinely invested in AMCs managing mutual funds, such as Warburg Pincus’s 49% acquisition of China’s Fortune SG asset management company. Recently, global PE firm Blackstone attempted to acquire L&T mutual fund, before HSBC ultimately acquired it. In India, PE funds are primarily structured in the form of alternative investment funds (AIFs). The easing of Mutual Fund Regulations to allow for pooled investment vehicles/PE funds to act as sponsors of mutual funds has been long sought after. The way the Mutual Funds Regulations and AIF Regulations are currently structured, there is no express prohibition on an AIF from acting as a sponsor. However, the regulations require a sponsor to fulfil certain eligibility criteria which creates a hurdle for any investment by an AIF.
One such condition is that a sponsor should be carrying on business in financial services for at least 5 years. Typically, each AIF is established for a fixed period and they may not fulfil the experience requirement. However, AIFs have sponsors and managers, which are usually firms or companies of experienced professionals. Hence, while an AIF may not fulfil this experience requirement, if SEBI adopts a ‘look through’ approach and considers the sponsor/manager of AIF, then this requirement may be fulfilled. The Working Group may even consider allowing an SPV to be set up, which would act as a sponsor, similar to the structure adopted by IRDAI for allowing PE funds to invest in insurance companies as ‘promoters’.
The net-worth is another eligibility criteria that an entity proposing to become a sponsor of a mutual fund has to satisfy. As per the mutual funds regulations, the net-worth of the sponsor should be positive in all the immediately preceding 5 years. Since the AIF may not have been in existence for 5 years, it may not satisfy this requirement. Another hurdle is the requirement for a sponsor to have profits in three out of last 5 years. This requirement has been amended in March 2021 such that the applicant is required to have a networth of INR 100 crore if the profit criteria isn’t fulfilled. Recognising the role of technology in financial services, SEBI introduced this amendment to allow larger penetration of mutual funds in the country by allowing not-yet-profitable fintech companies to apply for mutual fund licenses. This amendment has changed the mutual funds landscape by allowing many fintech companies to apply either organically for a new mutual fund license or inorganically enter this industry by acquiring existing AMCs. With respect to AIFs, an AIF pools the funds of investors and invests them across various investment avenues, as disclosed in the placement memorandum of the AIF provided to the investors. While it is possible for an AIF to have notional profits in the form of increase in the NAV of the units of AIF, actual profits are realized only at the time of the sale of the investments after considerable time. Thus, it may not be possible for an AIF to satisfy the conditions of having net-worth or realized profits in the years preceding the application. While the recent amendment is helpful, a special exception may also be introduced to address the unique situation in which AIFs are placed.
The Mutual Funds Regulations came into effect in 1996, whereas the AIF Regulations were enacted in 2012. While there have been subsequent amendments to the Mutual Funds Regulations, no clear and specific provisions had been introduced to allow AIFs to become sponsors of mutual funds. Easing the requirements to allow PE funds to act as sponsors is the need of the hour, which will lead to consolidation and innovation in this space. None of the hurdles mentioned above require any drastic amendments to the regulations which would impinge on the interests of the investors or safety of the institution. On the contrary, quite a few of the changes required are clarificatory in nature.
Venture capital and private equity have boosted the economy by infusing much needed capital into various entrepreneurial and other ventures. Allowing AIFs to become sponsor of mutual funds will lead to a healthy growth of mutual funds in India, and hopefully pave the way for a deeper penetration of mutual funds in the financial hinterlands of the country. Further, as we have seen in the case of Navi and Quant, this will pave way to innovation in the space, ultimately benefiting the investors.
The constitution of a Working Group is a step in the right direction. Bearing in mind the positive and forward-looking outlook of SEBI in developing the securities market in India, it is expected that the Working Group proposes positive changes to the Mutual Fund Regulations to allow for fresh investments to flow in.
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