I have a piece with Lipika Vinjamuri and Navneeta Shankar on the proposed changes in mutual fund sponsorship in today's Financial Express linked here. The full piece is as below:
A
“sponsor” is the nucleus of a Mutual Fund (MF) precisely because they are
responsible for promoting, bringing in capital and setting up a MF. It is
important to mention that the concept of a sponsor is a departure from the
usual rule of a company being a separate legal entity. Third parties are never liable
or responsible for either the financial or non-financials of a legal entity
once incorporated. The reason for the departure from the stated policy is to
introduce a promoting entity being responsible for the fund at a time the fund
is somewhat new and systems are still not fully in place for accountability.
Owing to this central role of a sponsor in a retail-oriented fund, the bar set
up by the Securities and Exchange Board of India (SEBI) for an entity to
qualify as the sponsor of a MF is quite high.
However, despite their important position, the general market trend
suggests that once an MF has crossed a certain mark for assets under management
(AUM), they earn a reputation and become established; and consequently, the
role of a sponsor in such MF begins to diminish and indeed should be eliminated.
According
to a recent statistic released by the Associate of Mutual Funds in India, the
domestic MF industry in India has witnessed a two-fold growth in the past 5
years in terms of AUM. This growth when quantified amounts to around Rs. 39.89
trillion as of December 31, 2022, from 21.27 trillion as of December 31, 2017.
This demonstrates that the MF industry has the potential for a lot more growth for
which new players may act as catalysts. Considering this, in April 2022, SEBI
set up a Working Group to review the role and eligibility of a sponsor of a MF.
As part of SEBI’s recently released consultation paper, the Working Group has
proposed an alternate eligibility criteria for Private Equity players (PEs) to enable
them to act as sponsors of MFs whilst also viewing the viability of having
self-sponsored Asset Management Companies (AMCs).
Over
the past few years, PEs have been allowed to act as sponsors of real estate
investment trusts, asset reconstruction companies and entities in the insurance
industry. In this light, it was observed that PEs have significant capital
which can be invested to drive innovation and growth, consequently leading to
constructive competition in the MF industry. With a view to enable the entry of
PEs into the MF industry, SEBI has proposed an alternate eligibility criteria
wherein a sponsor would have to capitalize the AMC in a manner, that the
positive liquid net worth of the AMC is not less than Rs. 150 Crores. In
addition to this, the minimum positive liquid net worth would have to be Rs.
100 Crores and the AMC would have to maintain such net worth till it has
profits for five consecutive years. Further, the minimum capital contributed
and minimum sponsor stake of 40 per cent would have to be locked-in for a
period of five years. While, on one hand, SEBI’s proposal to make the MF
industry more inclusive is laudable, however, on the other hand, the networth-based
eligibility criteria prescribed by SEBI defeats this purpose by invariably
erecting high entry barriers for interested players. As re-iterated in this
column many times, adding networth for smart businesses ensures rich people
rather than smart and ethical people enter. In any case, PE players do usually
come with scale and thus the networth may not by itself be a barrier for them
to enter. Further, it is far more likely that a PE enters as financial sponsor
of a running AMC rather than setting a greenfield venture. The core strength of
PEs is bringing large amounts of capital and ability to scale the business
rapidly. Thus once allowed, there will be mix-and-match between PE players and fund
managers bringing in capital from the former and expertise with the latter in a
jugalbandi of capital and expertise.
SEBI
has further observed that as MFs mature, AMCs acquire self-sufficiency and
maturity in running its operations in the interest of the unitholders, thereby
gradually reducing the sponsors’ obligations to insignificant activities.
Considering this, the Working Group has proposed a reduction of ownership of
the sponsor in the AMC over time from the current requirement of 40 per cent
and has floated the idea of a self-sponsored AMC without any sponsor. The
consultation paper highlights that a reduction of the sponsor’s stake in the
AMC will pave way for other significant shareholders, bringing in strategic
guidance, inclusivity, and good talent to fuel growth and innovation in the MF
industry. Moreover, with the presence of other investors in the AMC, MFs will
increasingly work in the interest of investors by engaging in fewer related
party transactions and minimising investment in instruments connected to the
sponsor, its associate or group companies. This would be an excellent move and
would counter-intuitively bring greater accountability of the mutual fund and
its manager, rather than relying on some third party, who knows little of what
is going on, to stand accountable.
The
consultation paper recommends that such reduction in the stake of the sponsor
may be achieved either voluntarily, where the AMC or the sponsor will have the
liberty to apply for disassociation; or mandatorily, where the reduction in
stake will be a regulatory requirement. In either case, the primary principle
for permitting disassociation of existing sponsors will be that the AMC itself
is able to meet the qualifying conditions for a self-sponsored AMC as
prescribed by the regulator. It is possible that the disassociation of existing
sponsors, as envisaged by SEBI, will result in some MFs continuing to have
sponsors, while some operating without any sponsors, hence inviting two sets of
compliance requirements catering to the specifications of each structure. A key
distinction will be that in the case of a self-sponsored AMC, all obligations
of a sponsor such as compensating for inappropriate valuation, maintenance of
minimum liquid net worth of AMC on continuous basis, etc. will be performed by
the AMC itself. The disassociated sponsor will be considered a ‘financial
investor’, and no obligation of a sponsor will apply to the disassociated
sponsor.
SEBI
is proposing to put in place ownership norms akin to those stipulated by the
Reserve Bank of India for banks, that requires promoters to mandatorily dilute
their shareholding in banks within a specified period as per the prescribed
guidelines. Given that the underlying intention is to usher in a new era of
self-sufficient AMCs, it is suggested that a mandatory reduction in the stake
of sponsors is the way to achieve this. At the same time, it is important to
gauge if a model mandating disassociation of sponsors will be practically
feasible for the AMCs presently operating in the Indian markets, who would then
be required to adopt these norms retrospectively. A more practical and
consistent model would be to allow sponsors to disassociate themselves
voluntarily after a period of maturity of the MF/AMC, without mandating a
divestment. The assumption that fragmented shareholding by itself is a good
things is questionable as we have seen in many banks. The regulator should let
a thousand flowers bloom from a control perspective so long as it is without
diluting accountability standards.
Overall,
SEBI’s proposals will go a long way in achieving fresh capital injection, encouraging
and fostering competition and innovation, enabling new players to enter the MF
space and providing an exit option to sponsors of AMCs. That being said, SEBI
will have to put in place more balanced provisions to ensure that PEs can enter
and sponsors can exit the MF industry comfortably while also protecting
unitholders’ interests against any market imbalances and disruptions that may
be caused due to such actions. As the Indian MF industry continues to grow and
evolve, it will be interesting to see how these proposals pan out in terms of
implementation in a market space that might be set in its ways of operation.
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