Revised parental requirement for mutual funds – a refreshing overhaul

I have a piece with Mihir Deshmukh and Suyash Sharma on the new norms of SEBI allowing both private equity and self-sponsorship of mutual funds in today's Financial Express. It's an important reform for the mutual fund industry which will reverberate for decades to come. The full piece is as linked here, tweeted here and reproduced below.

 

Securities and Exchange Board of India (SEBI) recently revised the regulatory framework applicable to sponsors of mutual funds, including provisions pertaining to change in control, eligibility criteria inter alia including, and introduction of provisions for self-sponsored AMCs. Parallelly, SEBI has also provided much required clarifications to the roles and responsibilities of trustees and asset management companies (AMC) in relation to core responsibilities of the trustees, unitholder protection, meetings between trustees and AMC etc. While first principle changes have been introduced through an amendment to the regulations, SEBI issued 2 circulars on the 7^th July to lay down specific provisions to give effect to the amended provisions.  

Eligibility criteria, and change in control provisions for sponsors

SEBI has introduced a variety of provisions in relation to the eligibility criteria, and change in control of sponsors. With a view to make the mutual fund space more accessible to new players, SEBI has introduced an alternative to the ‘sound track record’ criteria that allows an entity to sponsor a mutual fund if such entity has a net worth of 150 crore rupees, maintains a capital contribution of 150 crore rupees that is locked in for 5 years, appoints certain CXO level persons with a combined experience of over 30 years, and in case of acquisition of an existing sponsor, or a stake in such sponsor, the acquirer has a positive liquid net worth equal to incremental capitalization required to ensure minimum capitalization of the AMC, and shareholding equivalent to 150 crore rupees remaining locked in for a period of 5 years. The alternative criteria allows venture capital backed entities that may not have experience in providing financial services to sponsor mutual funds. Through the amendment and the corresponding circular, SEBI has also allowed private equity funds to be sponsors of mutual funds if such private equity funds comply with the sound track record requirements provided in the mutual fund regulations.

Taking in view, the maturity of the mutual fund industry, and the trust established with investors across various classes, SEBI, through the amendment and the corresponding circular, has also allowed existing sponsors to disassociate from the mutual fund, wherein, if a sponsor disassociates itself from a mutual fund, the shareholding of any shareholder in such AMC shall be below 10 percent. The amendment also allows for self-sponsored AMCs, and the July 7 circular provides various requirements for a self-sponsored AMC inter alia including that such AMC shall be providing financial services in the 5 preceding 5 years, have a positive net worth for all of the preceding 5 years, and have a profit of INR 10 crores in each of the preceding 5 years.

These new norms permit a wide variety of entities to enter the mutual fund industry while maintaining necessary prudential requirements. Permitting private equity funds and pooled investment vehicles to sponsor mutual funds fosters diversification of market participants and promotes healthy competition. The requirement for a new sponsor to ensure that the existing AMC acts as the sponsor in the event of dissociation and the imposition of a cap on shareholding for any shareholder in the AMC to less than 10% contributes to the overall stability of the industry. If the self-sponsored AMC is unable to fulfil these criteria within a one-year cure period, then either the dissociated or a new sponsor would have to become a sponsor after obtaining SEBI approval.  However, it remains to be seen how the framework would operate in situations where a self-sponsored AMC fails to maintain its eligibility for self-sponsorship and neither the dissociated Sponsor nor other entities are willing to assume the role of Sponsor on acceptable terms.

Governance norms for trustees and AMCs

In tandem with the revision of the eligibility criteria for sponsors, SEBI has revised the eligibility criteria for the AMC wherein, if the sponsor does not meet the sound track record requirements provided in Regulation 7 at the time of application, the minimum net worth requirement of the corresponding AMC would be 100 crore rupees against the usual 50 crore rupees, and the AMC would be required to maintain such net worth for a period of 5 years.

Further, SEBI has introduced a set of core responsibilities of the trustees under Regulation 18(25), in addition to the responsibilities provided under Regulation 18(25)(A)&(B). These core responsibilities inter alia include provisions such as review of performance of the AMC vis-à-vis peers or benchmarks, ensuring fairness in the fees and expenses charged, and preventing mis selling to increase valuation and AUM. The core responsibilities further require the trustees to address conflict of interest between various stakeholders and the unitholders, ensure that no undue advantage is given to group companies of the AMC/sponsor, and have adequate systems in place to prevent market abuse/misuse of information, and system level checks to prevent front running by employees.

The 7^th July circular for trustees and AMCs also requires the AMC to set up a unitholder protection committee under Regulation 25(24) that would be responsible for protection of the interests of unit holders of Mutual Fund schemes vis-a-vis all products and services provided by the AMC, review various compliance issues relating to protection of the interests of the unit holders, and education of unitholders regarding various mutual funds, investor charter, and complaint handling procedures. SEBI has also provided detailed guidelines regarding the constitution and functioning of such committee.

While the core responsibilities laid down for trustees further clarify the role and responsibilities of trustees while equipping them with additional tools to carry out the governance functions, the mandate for the AMC to constitute a Unit Holder Protection Committee further reinforces investor protection measures. This committee would be vital to ensure protection of interest of unitholders, adoption of sound and healthy market practices, related compliances, and informing investors.

In conclusion, SEBI's amendment to the mutual fund regulations and the corresponding circulars have significant implications for investors and the mutual fund industry as a whole. By emphasizing investor protection, transparency, and governance, these amendments aim to foster a robust and stable mutual fund ecosystem in India. Allowing new players will further deepen the markets while the additional governance and oversight norms ensure that funds, and their parents work in a fair manner towards the best interest of unitholders. Most significantly it will mark a significant departure though not an abandonment of the erstwhile dependence on liabilities of the shareholders of the AMC/Trustees (who go by the moniker sponsors), rather than the AMC/Trustees themselves. Philosophically, this a welcome move, as it holds a company, its directors and its management liable, rather than its shareholders as should be expected of a limited liability company. More importantly, the recognition of private equity and other funds as legitimate shareholders will drive significant competition and innovation in the industry.