By Sandeep Parekh
Securities and Exchange Board of India (Sebi) recently revised the regulatory framework for sponsors of mutual funds (MFs), including provisions on change in control, eligibility criteria, inter alia, and introduced provisions for self-sponsored asset management companies (AMCs). Parallelly, Sebi has provided much required clarification on the roles and responsibilities of trustees and AMCs in relation to core responsibilities of the trustees, unitholder protection, meetings between trustees and AMCs, etc. While first principle changes have been introduced through an amendment to the regulations, Sebi issued two circulars on July 7 to lay down specific provisions to give effect to the amended provisions.
The regulator has introduced a slew of provisions on the eligibility criteria, and change in control of sponsors. To make the MF space more accessible to new players, it has introduced an alternative to the ‘sound track record’ criteria that allows an entity to sponsor a MF if such entity has a net worth of Rs150 crore, maintains a capital contribution of Rs 150 crore that is locked in for five 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 capitalisation required to ensure minimum capitalisation of the AMC, and shareholding equivalent to `150 crore remaining locked in for five years. The alternative criteria allows venture-capital-backed entities that may not have experience in providing financial services to sponsor MFs. Through the amendment and the corresponding circular, Sebi has also allowed private equity (PE) funds to be sponsors of MFs if such PE funds comply with the sound track record requirements provided in the MF regulations.
In view of the maturity of the MF 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 MF, wherein, if a sponsor disassociates itself from a MF, the shareholding of any shareholder in such AMC shall be below 10%. The amendment also allows for self-sponsored AMCs, and the circular provides various requirements for a self-sponsored AMC, inter alia, including that such AMC should have been providing financial services in the preceding five years, have a positive net worth for all of the preceding five years, and have a profit of Rs 10 crore in each of the preceding five years.
These new norms permit a wide variety of entities to enter the MF industry while maintaining necessary prudential requirements. Permitting PE funds and pooled investment vehicles to sponsor MFs 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 sponsor or a new sponsor would have to become 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.
In tandem with the revision of the eligibility criteria for sponsors, Sebi has revised the eligibility criteria for the AMCs, 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 Rs 100 crore against the usual `50 crore, and the AMC would be required to maintain such net worth for a period of five years.
Further, Sebi has introduced a set of core responsibilities of the trustees under Regulation 18(25), in addition to those already 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 to prevent market abuse/misuse of information, and system level checks to prevent front-running by employees.
The July 7 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 MF schemes vis-a-vis all products and services provided by the AMC, review various compliance issues relating to the protection of the interests of the unit holders, and education of unitholders regarding various MFs, 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 their role and responsibilities and equip them with additional tools for governance, 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 of the MF regulations and the corresponding circulars have significant implications for investors and the industry as a whole. By emphasising investor protection, transparency, and governance, these amendments aim to foster a robust and stable MF 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. It will mark a significant departure—though not an abandonment—from the dependence on the liabilities of the shareholders of the AMC/trustees (who go by the moniker sponsors), rather than the AMC/trustees themselves. This a welcome move, as it holds a company, its directors and management liable rather than its shareholders as should be expected of a limited liability company. More importantly, the recognition of PE and other funds as legitimate shareholders will drive significant competition and innovation in the industry.
Co-authored with Mihir Deshmukh and Suyash Sharma, associates,
Finsec Law Advisors